How Radmacher pre-nup precedent may affect entrepreneurs

Following the Supreme Court’s pre-nup ruling in the case of Katrin Radmacher, Farrer & Co’s Richard Lane looks at the implications for entrepreneurs

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Following the decision of the Supreme Court last month in the case of Katrin Radmacher vs. Nicolas Granatino, Farrer & Co’s Richard Lane looks at the implications for entrepreneurs and the protection of shareholdings in the event of a divorce

The onset of divorce proceedings against a significant shareholder of a company can be disruptive both to the management and long-term direction of the business, should shares be required to be transferred to the spouse of the shareholder.

If an owner or a key director is embroiled in legal proceedings, inevitably they will be distracted to the detriment of the company. The solution to this depends on the extent of the distraction. Overall, directors should all ensure they are acting in the best interests of the business as a whole, rather than those of the individual shareholder.

How have shareholdings been protected up until the Radmacher case?

It has always been possible to protect against share transfers to unwanted third parties (including spouses and ex-spouses) by including appropriate restrictions in the articles of association preventing transfers. This can provide a shield against shares falling into the hands of individuals whose interests are not aligned with those of the company.

However, such provisions may not protect the assets of the shareholder in question, as it is likely that the court, in ancillary relief proceedings, would still take account of the value of the shareholding when assessing the spouse’s net value. The order for ancillary relief could be so substantial that the shareholder is forced to sell some or all of the shares (in accordance with the restrictions in the articles) to raise sufficient funds to settle the relief.

What is the likely impact of the Radmacher case on owner-managed firms?

In brief, the Radmacher case gives more legal force to pre-nuptial agreements, by identifying a principle that unless a pre-nup is unfair, the agreement will be decisive of the financial outcome of the marriage. In determining fairness, the court will look at a range of relevant considerations, including (but not restricted to) whether the husband and wife entered into the agreement of their own free will without undue influence or pressure, and were suitably informed of its implications.

This new principle certainly bolsters the advice lawyers should be giving to their entrepreneur clients and family run businesses: pre-nuptial agreements are now a more effective part of protecting an individual’s assets (and a company’s shareholding), providing due care and attention is given to ensuring the agreement is fair at the time that it is signed. In addition, entrepreneurs and spouses who wish to pass business assets to the next generation unencumbered by any unforeseen divorce proceedings should also take note of the enhanced status of pre-nuptial agreements.

Compelling shareholders to sign pre-nups

One step further than this would be for the company to compel all shareholders to enter into a pre-nuptial with their future spouses. This might be in the form of a shareholders’ agreement with a clause stating that, in the event of a marriage of the shareholder, the shareholder must sign a pre-nup, which states that the spouse is not entitled to any shares following a divorce. These provisions are not unheard of in the world of American hedge funds and in other jurisdictions.

Such provisions, however, raise some serious questions. In terms of the effectiveness of the pre-nuptial, is it fair that a spouse has to sign up to a provision which has effectively been determined by a third party to the marriage (ie the other shareholders)? In respect of the shareholders’ agreement, the clause may be contractually binding, but what happens if the shareholder or respective spouse does not sign the agreement? Is the shareholder in breach of the agreement and should he or she be forced to sell his or her shares to the other shareholders; or would the breach give rise to a claim for damages and if so, what is the loss?

Conclusion

Companies and shareholders already have some tools at their disposal to protect a company’s long-term interests. Should private businesses be encouraging shareholders to sign pre-nuptial (or even, in the case of those already married, post-nuptial) agreements in light of Radmacher? Almost certainly, but whether they can or should compel shareholders to do so is a matter for some consideration yet.