Even though no entrepreneur enters the business to incur losses, various expected and unexpected situations can lead to a business becoming unprofitable. In such cases, the business owner may seek to exit the business and salvage what they can. Another common scenario is when a marriage becomes dysfunctional over the years, eventually leading to divorce. The divorce then becomes a battle over shared assets, negatively impacting the business and its continuity.
This article focuses on the most common problems affecting family businesses and how appropriately established legal relationships between spouses can help eliminate these issues.
The Impact of Marriage on Business Income
According to Slovak law, upon entering marriage, spouses begin to acquire, with certain legal exceptions (such as inheritance, gifts, restitution, items for personal use or professional purposes), joint ownership of all assets in an undivided co-ownership (“UCO”). A UCO means that all assets belonging to the UCO are in joint ownership, and each spouse has equal rights to access said assets.
It’s important to note that a UCO cannot be entirely eliminated between spouses by agreement. However, it can be modified through a notarial deed by expanding or narrowing the list of assets included in the UCO. A crucial detail often overlooked by spouses is that a UCO can only be modified for the future. This means that assets already a part of the UCO cannot be excluded, such as real estate acquired by the spouses in the past. Slovak law also does not allow for prenuptial agreements where prospective spouses can modify or entirely exclude the acquisition of assets into a UCO during marriage. However, it is essential to recognize that only newly acquired assets during marriage become part of a UCO. This does not include assets acquired by the spouses before marriage. Income generated by assets exclusively owned by one spouse (e.g., rental income from property, share of company profits) and, similarly, wages or business income also fall under the UCO.
Another factor affecting the spouses’ assets is that the debt of one spouse incurred during the marriage can be paid through the execution of the assets belonging to the UCO. Therefore, spouses should assess the level of risk in any business activities that could jeopardize their joint assets. If the risk of business activities is high, spouses should consider the modification or total cancellation of the UCO.
The Option to Cancel a UCO
Joint ownership of spouses is always canceled with the termination of marriage. During the marriage, a UCO can only be canceled by a court if one spouse files a petition for its cancellation, and only in exceptional situations. The court can only cancel UCO during the marriage if its continuation goes against good morals or if one spouse starts entrepreneurial activities. In the case of entrepreneurial activities, only the spouse not engaged in business can file a petition for UCO cancellation. If both spouses are entrepreneurs, either of them can file for cancellation. If the condition that the other spouse started entrepreneurial activities is met, the court has no choice but to grant the petition and cease UCO.
If the UCO is ceased, arrangements must be made to ensure that the other spouse, particularly the one who manages family affairs, participates in the income generated by the entrepreneurial spouse. The law only addresses situations where the non-entrepreneurial spouse actively participates in the business after the cancellation of the UCO, in which case business income is divided equally between spouses. However, the income distribution can be modified by a written agreement between spouses. If the non-entrepreneurial spouse does not actively participate in the business after UCO cancellation, mechanisms must be established to ensure that business income belongs to both spouses. This safeguards the non-entrepreneurial spouse in case of divorce, ensuring they have a claim to assets acquired by the entrepreneurial spouse. Similarly, if the entrepreneurial spouse transfers part of their income to the non-entrepreneurial spouse, it can protect the “family assets” in the event of the entrepreneur's debts since creditors cannot satisfy their claims from assets transferred to the non-entrepreneurial spouse. This is assuming the entrepreneurial spouse did not transfer the assets to the non-entrepreneurial spouse with the intent to hinder the creditor’s collection.
Ownership Interests in Companies and UCO
In practice, protecting the private assets of spouses is often achieved by having one spouse conduct business through a capital company. The entrepreneurial spouse is typically a shareholder in a limited liability company (“LLC”) or a joint-stock company. There is a difference between the settlement of a business share in an LLC and shares in a joint-stock company.
If the business share in an LLC was acquired during a UCO, its value must be settled post-UCO cancellation. Judicial practice has determined that the business share is consistently awarded to the spouse who is a shareholder in the company. However, the value of the business share must be determined during the UCO settlement. During the settlement, the size of the business share on the day of UCO cancellation (date of divorce or the final court decision on UCO cancellation) is considered, preventing situations where the spouse could transfer part or all of the business share to another person during the period between UCO cancellation and its settlement. An interesting aspect of judicial practice is that the value of the business share is determined on the date of settlement and not on the date of cancellation. This puts the non-shareholder spouse in a weaker position, as there are creative ways to reduce the value of the business share, especially when the shareholder spouse has control over the company. Another challenge in settling the value of the business share is determining the value on the “day of settlement” since it is unknown in advance when the court will make a definitive decision about the settlement, making it impossible to establish the value on a future date. During legal proceedings, the value of the business share must be repeatedly re-evaluated, incurring unnecessary additional costs. In practice, we often encounter cases where the settlement of a UCO can last for over ten years when the company is already in a completely different position on the market than it was at the time of the UCO cancellation.
This settlement regime for business shares does not contribute to business prosperity, as the entrepreneurial spouse knows that the more successful the company becomes, the more they will have to compensate the other spouse during the UCO settlement.
A different situation arises with shares of a joint-stock company. Since shares belong to the UCO, they need to be settled after the UCO cancellation (not just prescribed a value). When settling the shares of a majority shareholder, the divorce can significantly impact the operation of the entire joint-stock company.
Conclusion
Family businesses can entail numerous consequences that spouses often fail to fully grasp before crises occur. Oftentimes, when a crisis in a family business arises, it’s too late, and a spiral of legal proceedings and questionable asset transfers begins, leading to additional legal actions. Proactively established mechanisms ahead of crises can effectively protect the assets acquired by spouses and ensure business continuity. In business partnerships, it has become standard for partners to establish strong relationships from the start, which can handle scenarios where one partner decides to leave the company or how to handle disagreements between partners. Despite this, when conducting business during marriage, insufficient attention is given to securing risks in the event of a crisis. Identifying future risks in the family business and correctly setting up mechanisms for business operation and potential termination can save substantial financial resources, protect family assets, and ensure the continuity of the business in the long run.
This article has been brought to you by Falath & Partners.
Authors of the article:
Ján Falath, Managing Partner
Vladimír Sedliak, Associate
