Don’t let a breakup break up your business

When it comes to talking business and considering risk, often the last thing that comes to mind is what might happen to the business if a personal relationship ends. While it might not be front of mind, it is still an essential consideration as New Zealand relationship property law can turn a business into a battleground in the event of separation.

Relationship property law

Under the Property (Relationships) Act 1976 (PRA), relationship property generally includes the family home, family chattels, all income earned during the relationship and assets acquired during the relationship (relationship property). On the contrary, separate property is defined as all property of either partner that is not relationship property, and includes property acquired prior to the relationship, property acquired out of separate property or an increase in value of separate property (separate property).

Upon the end of a qualifying relationship (marriage, civil union, or de facto relationship of over three years), the general presumption is that all relationship property will be equally divided while separate property will be retained by the owner of that property.

When a business is relationship property

It is a common misconception that if a person owns their own business (and whether they operate as a sole trader or through a company or other entity) it is their separate property. Unfortunately, this is not always the case. Regardless of how a business is owned, and whether or not both partners are involved, it may be considered relationship property. Some examples of where a business may be considered relationship property are:

1. If the business started during the relationship. Regardless of who set it up and who owns it (or contributes), assets acquired or enhanced during the relationship can be deemed relationship property.
2. Where contributions of either partner have led to an increase in the value of the business (even if the business predates the relationship). Contributions could include financial contributions (such as direct payments or retained earnings) or non-financial contributions to the business (such as administrative support or managing the household and childcare). Again, the increase in value may be relationship property regardless of whose name the business is in.

What happens to a business if the relationship ends

If your business is relationship property, and you and your partner separate, you will need to jointly decide who will retain it or how it will be divided. This could involve selling the business and dividing the proceeds or one of you buying out the other for an agreed sum (usually after obtaining specialist valuation advice from a business valuer). In the worst-case scenario, if you and your partner cannot agree, the future of the business could end up in the hands of the courts.

Protecting your business

There are safeguards that can be put in place to pre-empt what should happen to the business in the event of separation. The most effective way to do this is to sign a contracting out agreement (COA) with your partner either during the early stages of your relationship or of the business. A COA allows you and your partner to opt out of the PRA’s default rules, meaning that you can agree what will be relationship property and what will be separate property.

Without a COA, some other options and considerations are set out below:

1. Be mindful about using your income to support or invest in your business, as doing so may change the classification of your business, or its increased value, from separate property to relationship property. The reason for this is that any income earned during the relationship is considered relationship property under the PRA.
2. Make sure you are paying yourself a market salary. The courts have been prepared to find that retained earnings (and therefore depriving the relationship property pool of a market salary) can amount to an application of relationship property. If established, this could create a relationship property claim over the increase in value of the company from the first “application” of retained earnings.
3. If you operate your business through a company, you can put in place governing documents for the company (i.e., a shareholders’ agreement and constitution) which set out how decisions are made, how disputes will be resolved, and exit plans for the parties. Tailoring governing documents to your circumstances can provide a framework to enable your business to operate smoothly, if/when the personal relationship changes or ends. This is particularly relevant if you are in business with third parties (who may not want to be in business with your partner if your relationship ends).
4. If you hold shares in a company (which operates your business), you may choose to hold these through a trust rather than in your personal name. While a trust can provide asset protection, it is not a foolproof way to protect your business from being considered relationship property. Shares transferred to a trust during a relationship can be relationship property if the courts consider the transfer defeated the sharing of relationship property – even if that was not the intended effect.

Too often business owners only learn about the implications of relationship property law once it is too late, at the point they engage a lawyer because of a separation. By being aware and taking active steps to protect your business, you can put yourself (and your business) in a better position, should you ultimately experience a relationship breakdown.