When business-owners marry, they often neglect to take one of the easiest and most cost-effective steps toward protecting their business interests from the ravages of an unforeseen divorce. Without a precisely drawn premarital agreement (also known as a prenuptial agreement), a business-owner can find as much as 50% (or more) of his business in the hands of a former spouse.
Each business (and each couple) has different considerations that must be identified and addressed. A few of the many issues relevant to business-owners who are about to marry include the following:
- Businesses of any structure or size: A carefully drafted PMA is important to business interests of any structure or size. It can protect your mom and pop grocery or your stock ownership in a multinational corporation.
- Small-business owners: You might be a sole owner or a partner in a closely-held business. The effects of a divorce on the business of a sole proprietor can be severe, indeed, but they can be even more damaging when you share the ownership of the business with others. Your partners or fellow stockholders may also be affected by your divorce if you fail to take steps to protect your interest from going to your spouse.
- Family businesses: If your business is family-owned and -run, your family members will have a strong interest in keeping the business in the family. This is true for both large and small family businesses. If part of your interest goes to your spouse when you divorce, what may have been a decades-long family tradition will be irrevocably changed.
- More than One Business: Both you and your spouse may have separate businesses. Your PMA can keep them separate upon your divorce (and during your marriage) and insure that the debts from one cannot be satisfied from the assets of the other.
Equitable Distribution: Marital Property vs. Non-marital Property
When you divorce, your assets are categorized as Marital and Non-marital Property, and the Marital Property is fairly divided between you and your spouse. The Non-marital Property remains in the hands of whichever spouse “owns” it at the time you divorce.
Non-marital Property is defined as 1) property acquired before marriage, or 2) property acquired by gift or inheritance. Marital Property is defined as 1) property acquired during marriage, or 2) the increase in value of Non-marital Property that occurs during marriage.
But, here is an important addition: Non-marital Property also includes anything that would have been considered Marital Property that you and your spouse agree to designate as Non-marital Property. This is where the PMA comes in. If you agree to designate certain otherwise Marital Property as Non-Marital Property, it will not be subject to division when you divorce.
What we’re concerned with here is the increase in value during marriage of a business interest you acquired before your marriage and any additional business assets you might acquire while you are married. Unless you execute a valid and enforceable PMA to the contrary, every bit of that increase in value and every one of those assets will be Marital Property subject to division by the court.
The Law of Premarital Contracts in Pennsylvania
Pennsylvania law not only permits but encourages parties to enter agreements that determine their marital property rights and take the distribution of that property out of the hands of the courts. However, simply executing a PMA will not automatically protect you; you need to do it right. The rules are somewhat complex, so that the assistance of an attorney experienced in family and business law may be crucial to achieving this goal.
Note: Though the advice of an attorney in drafting a PMA is not required for its enforceability, it is a very good idea, for reasons mentioned below.
The Pennsylvania Divorce Code provides that parties will be bound by their PMA unless the person seeking to avoid it can prove by clear and convincing evidence that he did not enter the agreement voluntarily (i.e., that it was entered into under duress), or that he was not given full and fair disclosure of the financial position of the other party or did not voluntarily waive, in writing, the right to such disclosure (i.e., that he was induced to enter the contract through fraud or misrepresentation). There are ways to make reasonably sure a PMA holds up to any such challenge.
PMAs are contracts like any other, and are interpreted in accordance with traditional principles of contract law. Thus, as is true of contracts generally, spouses will be bound by the terms of a PMA, absent a sufficient showing of fraud, misrepresentation, or duress.
Put another way, the voluntariness and full disclosure requirements are all that need to be satisfied. As long as those requirements are met, the parties will be bound even if the agreement is unfair or fails to strike a “good bargain” for each party. They will even be bound if the terms were not read or fully understood. The law assumes that parties are capable and intelligent enough to understand the terms and consequences of any contract they freely make.*
Challenges to the Enforceability of Premarital Agreements
Let us assume you have a PMA in place and your soon-to-be-ex-spouse is attempting to convince the court that the agreement should not be enforced. Your spouse may do so either by 1) claiming the agreement was involuntary or 2) that he was induced to enter it through fraud or misrepresentation because you failed to fairly and fully disclose your financial situation at the time it was executed.
Because the agreement must be evaluated according to contract law, the first thing the court will do is look at the wording of the contract. The language will help the court determine the intent of the parties as well as whether the requirements of voluntariness and full disclosure have been met. The precise wording of the agreement can make the difference between a court enforcing and not enforcing your contract.
The Clearly-Worded Agreement
If the contract states in clear language that the parties are fully aware of the terms of the contract, that they understand the rights they are giving up, and that they freely agree to do so, the court will presume from this language that the contract was voluntarily entered into. If each party relies on the advice of separate and independent counsel—and states so in the agreement—this will strengthen the presumption of voluntariness even further. In the face of such a clear statement, your spouse will face quite a hurdle in his/her attempt to prove the agreement was something other than voluntary.
Likewise, if the contract states in clear terms that the parties have fully disclosed to each other their financial obligations and property at the time of the agreement (or that they have waived their rights to receive such disclosure), your spouse will be hard-pressed to prove otherwise. If, in addition, the contract provides that you both understand the agreement and intend to be bound by its terms, a court will enforce your agreement as written unless your spouse manages to prove fraud or duress despite the clarity of the contract’s statements to the contrary. Including a statement that both parties received the advice of independent counsel will help to support your claim of full and fair disclosure, as well.
In other words, the clear language of your contract will both demonstrate your intent and go a long way toward counteracting your spouse’s claims of fraud or duress. In that situation, the terms of your agreement, as written, will very likely be enforced.
The Disadvantages of an Unclear Agreement
Let us now assume that you drafted a PMA without assistance and that your contract is somewhat ambiguous. Even if your spouse cannot prove fraud or duress, the court will need to consider evidence outside the language of your contract before it can enforce its terms. Until the court determines what your contract means, the court cannot enforce it.
When the court needs to determine a contract’s meaning by considering something other than the language of the contract itself, the court is required to give the person who did not draft the contract the advantage. If it can be interpreted in a way that will be to your advantage (assuming you are the one who drafted it), but can also be interpreted to give your spouse the advantage, the interpretation favoring your spouse is the one the court must go with.
Your unclear contract may have an additional unfortunate effect: If the contract does not clearly state that it was voluntarily entered into and that full and fair disclosure was made, both voluntariness and disclosure will need to be established by evidence outside the language of the agreement.
Thus, a contract that spells out in clear, everyday language what you and your spouse agree to–and that you have made the agreement voluntarily and after full and fair disclosure–will significantly reduce your spouse’s chances of convincing a court not to enforce the agreement. It may even have the added benefit of discouraging your spouse from challenging the contract to begin with.
Your Spouse’s Claims of Duress or Lack of Full Disclosure
Remember, even if your contract is clearly worded, so that the court is able to enforce it as written, your spouse may still be able to convince a court not to enforce it if he can provide clear and convincing proof of duress or fraudulent misrepresentation. What sort of evidence does your spouse need in order to demonstrate duress or fraudulent misrepresentation?
Duress: a Contract Not Voluntarily Entered Into
A spouse who claims to have involuntarily entered into a PMA will need to show by clear and convincing evidence that he was subject to duress in making the agreement. Clear and convincing evidence is evidence so strong that a court is able to come to a conclusion without hesitation regarding the truth of the precise facts in issue.
In order to meet this burden regarding a claim of duress, your spouse will need to demonstrate that he was faced with a degree of restraint or danger (either actually inflicted or threatened and impending) that was so severe as to “overcome the mind of a person of ordinary firmness,” and that it compelled him to enter the contract against his will.
This is quite difficult to manage. Daily badgering and pressure to sign an agreement will not be enough. On the other hand, simply having access to the advice of an attorney may defeat a claim of duress unless there were actual threats of personal harm.
You might also want to avoid presenting and executing the agreement shortly before your wedding. Giving your spouse time to think about the contract will weaken any claim of duress.
Fraud or Misrepresentation: Lack of Full and Fair Disclosure
Full and fair economic disclosure is absolutely required in order to uphold a PMA. Thus, a spouse seeking to avoid such an agreement will be likely to assert that you engaged in fraudulent misrepresentation in the disclosure of your financial position and that he would not have signed the agreement had you been truthful.
If your spouse seeks to have your PMA declared unenforceable in this manner, he will need to show 1) that you misrepresented your financial position, 2) that your misrepresentation was important to his decision to sign the agreement, 3) that you knew your statements were false or that you made them with reckless indifference to whether they were true or false, 4) that you intended to mislead him into relying on your statements, 5) that he was justified in relying on your statements, and 6) that he was induced to give up certain of his rights as a result of his reliance. He must prove all this, moreover, by the same clear and convincing standard described above.
Again, this is an extremely difficult standard to meet, and your spouse’s assertion that he was naïve and gullible will be to no avail. The courts will judge the reasonableness of his reliance by the same standards they use for any contract.
It is important to note that in order to meet the requirement of full and fair disclosure, an exact accounting or precise financial statement need not be included as part of the agreement. In other words, the details of the disclosure do not need to be spelled out in the PMA. But a statement that the disclosure was made (though the details of the disclosure are not included) will raise the presumption that it was made and put the burden on the party claiming fraud to prove it was not. Including the details—though they are not required—will strengthen your claim of full disclosure, as well.
This article touches on just a few of the many issues that must be addressed when contemplating a business-protective PMA. As the terms must be tailored to fit your particular business and financial situation, the advice of an attorney in drafting your PMA is highly recommended.*A PMA can determine the disposition of property not only upon divorce, but upon death. This is of special significance where children of a previous marriage are involved. A PMA can also be used to protect your business assets from any debt incurred by your spouse before, during, or after marriage.