Why standard shareholder agreements don't protect you under Australian law
There is a significant gap in how most Australian business owners think about protecting their company. They invest in shareholder agreements, corporate constitutions and carefully negotiated governance structures, then assume the hard work is done.
What they don't account for is this: when a business partner goes through a divorce, your meticulously structured commercial arrangements may count for very little. The business itself becomes a battleground and you, as a co-shareholder, are caught in the middle of it.
Relationship breakdowns are a reality for many Australians and when business ownership is involved, the consequences can extend far beyond the individuals separating. The impact can affect business control, succession plans, cash flow and the long-term stability of the company itself.
This article explores why that risk exists and the steps business owners can take to better protect their interests.
The legal reality
Many business owners assume their Shareholder Agreement or Company Constitution will protect them if a co-owner's marriage breaks down, but the Courts have repeatedly shown otherwise.
In Commissioner of Taxation v Tomaras [2018] HCA 62, the High Court confirmed that the Family Court's powers can extend to third parties where necessary to achieve a just and equitable property settlement. While the case concerned tax liabilities, it highlights the potential for family law proceedings to affect parties beyond the separating couple, including creditors, trusts and business structures.
For business owners, the practical takeaway is significant.
Restrictions contained in shareholder agreements, company constitutions and other commercial arrangements are not necessarily the final word if the Family Court determines a different outcome is required to resolve a matrimonial dispute.
Just as importantly, a business partner's divorce does not remain their problem alone. Where an ex-spouse seeks orders that affect company shares, ownership structures or business assets, other shareholders may be required to participate in the proceedings to protect their interests. This can mean being served with Court documents, obtaining independent legal advice and becoming directly involved in a dispute that began entirely outside the business.
The result is that even if your own relationship is intact, a co-shareholder's separation can expose you to legal costs, management distraction, commercial uncertainty and the risk of court-ordered changes to the ownership structure of the Company.
How a shareholder's divorce can affect a business
Valuation and the discovery process
Before any property settlement can be reached, the value of the shareholder's interest in the business must be determined. This often involves extensive financial disclosure and scrutiny of company records.
Forensic accountants may be given access to tax returns, profit and loss statements, shareholder loan accounts and banking records to assess the value of the business. Depending on the circumstances, commercially sensitive information such as client lists, strategic plans and pricing structures may also become part of the discovery process.
At the same time, the shareholder involved in the separation is often dealing with significant personal and financial pressures, which can affect their focus and availability within the business.
Disputes and management distraction
Valuing a privately owned business is rarely straightforward.
Different experts can reach very different conclusions depending on the assumptions they apply and the methodology they use.
A spouse's valuer will generally seek the highest possible valuation to maximise the property pool, while the business owner may argue for a lower value based on factors such as market conditions, key-person dependency, limited marketability or minority ownership interests.
These disputes can continue for months or even years, consuming valuable time, increasing professional costs and diverting attention away from running the business.
Settlement outcomes and business consequences
Once a value has been established, the Family Court has a range of options available when determining a property settlement.
In some cases, a shareholder may need to fund a buyout of their spouse's entitlement, placing significant pressure on personal and business finances. This can result in working capital being withdrawn from the business or additional debt being taken on to fund the settlement.
In other situations, shares may be transferred as part of the settlement, potentially introducing an ex-spouse into the ownership structure with rights to information and participation in company decisions.
In more complex matters, the court may determine that the sale of business assets or even the business itself, is necessary to facilitate a just and equitable division of property.
Why most Shareholder Agreements fall short
Many Shareholder Agreements include a list of trigger events that require a shareholder to sell or transfer their interest in the business. These commonly include death, permanent disability, bankruptcy, serious breaches of the agreement or the termination of employment.
Relationship breakdown, however, is often overlooked.
If separation or divorce is not specifically identified as a trigger event, the remaining shareholders may have no contractual mechanism to acquire the affected shares before Family Court proceedings are finalised. By that stage, the options available to protect the existing ownership structure may be significantly reduced.
As a result, business owners can find themselves facing a range of commercial risks, including unexpected changes to ownership, pressure on cash flow from buyout obligations and, in extreme circumstances, the forced sale of business assets or the business itself.
Building better protection into your shareholder agreement
Define relationship breakdown as a trigger event
Your Shareholder Agreement can expressly provide that separation or divorce constitutes a trigger event, giving the remaining shareholders a right of first refusal to acquire the affected shares.
Creating a mechanism for shares to be transferred before a final property settlement is determined can help keep ownership within the existing shareholder group and reduce the risk of external parties becoming involved in the business.
Lock in a pre-agreed valuation method
Valuation disputes are often one of the most costly and time-consuming aspects of a property settlement involving business interests.
A shareholder agreement can reduce this uncertainty by specifying a clear valuation methodology in advance, such as an EBITDA-based formula verified by a nominated chartered accountant. Where appropriate, legitimate minority ownership discounts may also be incorporated into the valuation process.
Establishing the methodology upfront can significantly reduce the scope for future disagreement.
Include instalment-based payout terms
Even where a buyout is necessary, requiring payment within a short timeframe can place unnecessary strain on the business.
Carefully drafted instalment provisions can allow a buyout to occur over several years at a commercially reasonable interest rate, helping preserve working capital while still ensuring the departing shareholder receives fair value for their interest.
Require Binding Financial Agreements from shareholders
For many businesses, the strongest protection comes from requiring shareholders to maintain a Binding Financial Agreement (BFA) with their spouse or de facto partner.
A shareholder agreement can make this a condition of ownership. The BFA can then provide that, in the event of separation, the spouse agrees not to make a claim against the business shares and instead receives value from other matrimonial assets, such as the family home or superannuation.
While not appropriate in every circumstance, this approach can provide a significant additional layer of protection for both the shareholder and the business.
Aubrey Brown Lawyers
Is your current agreement actually protecting you?
Protecting a business from the personal circumstances of its owners requires expertise that sits at the intersection of commercial and family law. Too often, these issues are considered separately, creating gaps that only become apparent when a dispute arises.
At Aubrey Brown Lawyers, our Commercial and Family Law teams work together to help business owners identify risks early and put practical protections in place before problems occur.
A review of your current Shareholder Agreement should ask:
- Does your agreement define relationship breakdown or separation as a triggering event?
- Is there a pre-agreed, formula-based valuation method that applies on divorce?
- Do your payout terms protect the company's cash position over time?
- Are your shareholders' personal circumstances covered by Binding Financial Agreements?
Taking these steps is not about anticipating the failure of a business partner's relationship. It is about applying the same rational risk management to personal circumstances that you already apply to financial, operational and commercial risk.
If you need professional advice on your current or new shareholder agreement, please contact our office on 4350 3333 to make an appointment with a member of our team.
