What exactly is a “high-net-worth” divorce?
A high net worth divorce has traditionally been defined as a divorce involving more than $1 million in net liquid assets. Today, that number has increased substantially and we see more and more cases involving multiple millions of dollars. We’ve handled cases involving hundreds of millions. When it comes to the equitable distribution of marital assets in New York, there is basically a four-step process. You must first Identify the Assets; then Categorize Each Asset as either marital, separate, or a combination of the two; then Value the Marital Components of each asset; and finally Distribute these Assets Equitably between the parties, taking into consideration what is called “tax-impacting.” A high-net-worth divorce usually involves unique challenges largely related to the identification, valuation, and distribution of the couple’s assets. Those who’ve worked hard to acquire this type of wealth have lots more at risk than others not so fortunate. High-net-worth couples need an attorney with experience handling these types of cases to reduce their risk and ensure that the end result is a full and fair asset distribution.
What are high-net-worth clients's divorce challenges
Even if it’s just the house and retirement accounts that need to be settled upon, distributing assets in divorce can be complicated. Valuations of even the most common assets can become points of contention. In financially complex divorces, couples often have assets that are more difficult to identify and distribute, or potentially easy to overlook. Assets may be either tangible or intangible. They usually include commercial as well as residential real estate, ownership interests in different types of businesses, and professional practices. At times they involve post-marriage appreciation of separate property, stock options, intellectual property such as copyrights, patents, and goodwill, celebrity status and contingent interests. Of these, stock options, restricted stock, and contingent interests are some of the most complicated and difficult assets to distribute fairly. Sometimes these cases involve foreign bank accounts or foreign trusts, and they “tracing” to ferret out hidden assets. There are many issues that must be carefully evaluated prior to the distribution of marital property in a high asset, multi-million dollar divorce case. There can also be concerns about publicity and, sometimes, business partner resentment which can be better contained by a divorce lawyer experienced in handling such situations.
Asset valuation & distribution issues in high-net-worth cases
For wealthy couples, the valuation and distribution of assets can be the most important aspects of a divorce. The selection of a valuation date for a particular asset can make a substantial difference in the amount one gives or receives for it due to any fluctuation in value while the divorce case is pending. In New York, valuation dates must be between the date the divorce action is commenced and the trial date, depending upon what is “equitable.” And what is equitable can lead to substantial disputes. For example, if the value of a business or professional practice is greater at the time of trial than it was at the time the divorce action was commenced, one might argue that this appreciation in value is due to their active individual efforts and therefore, the valuation date should be as of the time the action commenced. However, their spouse might argue that the appreciation is the result of passive market conditions, hence the valuation date should be as of the date of the trial. Valuation date disputes can involve other types of assets as well, such real estate and non-discretionary securities accounts where the client, not the broker, makes all the trading decisions. Once they get over these types of hurdles, and the valuation of the asset is determined, the next step is to decide how much of that value (or what percentage of it) should be distributed to each spouse based upon their respective contributions to the acquisition of that asset, the value and marketability of the asset, and tax consequences of a proposed disposition of the asset.
Is it better paying additional spousal maintenance or buying out interests?
I would not recommend that a business owner pay additional spousal maintenance in lieu of buying out their spouse’s interest in a family business. In essence, it disguises the distribution of an asset as spousal support, or what is now called “spousal maintenance” or “maintenance” in NY (although it is still called “alimony” on federal income tax returns). Sometimes, divorcing couples can consider doing an income tax rate arbitrage to have the IRS pay some of the maintenance disguised as equitable distribution. Tax Rate Arbitrage is the practice of profiting from the differences in the way transactions are treated for tax purposes. The complexity of tax codes often allows for many incentives, which drive individuals to restructure their transactions in the most advantageous way in order to play the least amount of tax. Some forms of tax arbitrage are legal while others are not; that’s where a good tax attorney comes in. Although we always look to structure our clients’ transactions in the most advantageous way in order to pay the least amount of tax, we work with highly experienced tax attorneys to make certain that this structure is legal. In this example, I do not recommend that divorcing spouses continue joint ownership in a family business because of the likelihood for future disputes. This can bring them back into court but this time in the commercial part. There are many ways to buy out a spouse’s interest in a business that should be considered instead of paying additional maintenance.
What expenses to be taken into account in divorce?
Company cell phones, cars, and paychecks for the children are non-essential business expenses that would be considered by a Fair Market Value (or FMV) buyer and FMV seller in a hypothetical sale. A forensic accountant would add them back to cash flow in the Normalization Process. The Normalization Process refers to adjustments made in business valuation methodology, the goal of which is to estimate future expected cash flow that a potential buyer can reasonably expect to receive in return for his or her investment and to present information that is on a basis similar to that of other companies in its peer group. There are various categories of “normalization” adjustments that can be made depending upon the particular set of facts and circumstances. For example, Excess (or Deficient) officers’ compensation or benefits; Excess or below-market rent paid to a shareholder, personal travel and entertainment expenses. Going through the Normalization Process will result in the valuator using normalized income that will better reflect the true economic income of the particular business and allow for a better comparison with other similar businesses and their values.
What is the first step after being served with divorce papers?
After being served with divorce papers, a business owner’s first step be should be to retain an attorney experienced in complex divorce cases. In New York, when divorce papers are served, the defendant is notified of the existence of certain “automatic orders” that impose certain restrictions designed to maintain and preserve the status quo of marital property. These automatic orders include prohibitions against the transfer, removal, or withdrawal of any property owned jointly or individually by the parties. This includes bank and retirement accounts, but exceptions are allowed in order to hire an attorney and pay normal business and personal expenses. In addition, all insurance must remain in place during the divorce. That includes medical insurance, life insurance, as well as homeowner’s and automobile insurance. Once the business owner has retained an attorney, he or she can discuss asking the court to modify any of its’ automatic orders.
How could executive compensation affect a divorce settlement?
Some of the esoteric executive compensation arrangements will be added to the marital estate and will likely also be considered prospectively in one’s earning power. These include things like: a “sign on” bonus, forgivable loans, performance bonus, a “stay on” bonus, stock options, phantom stock options, restricted stock, and restricted stock units. Rabbi trusts may also be a factor during divorce. Called a Rabbi trust due to the first initial ruling made by the IRS on behalf of a synagogue, these forms of trusts create security for employees because the assets within the trust are typically outside the control of the employers and are irrevocable. Sometimes referred to as “grantor trusts”, these trusts are created for the purpose of supporting the non-qualified benefit obligations of employers to their employees.
What might happen during divorce to a spouse’s stock options?
If the stock options were received during the marriage, they are part of the marital estate and will likely be valued by a forensic accountant. They will either be actually distributed in kind to the parties or be part of the estate “true up”. By “true up” we mean included and considered in the valuation and distribution of the marital estate to each spouse, although not actually divided between them in kind. Stock options and restricted stock are compensation based on an implied promise of future riches – but with no guarantees. Determining the current value of stock options and restricted stock for a privately-held company can be difficult. Obviously, stock options are meant to benefit the employee or they wouldn’t be a viable part of a compensation package. But before the options are exercised and the stock is sold, nobody knows how much they will actually turn out to be worth. Determining the current share value for many publicly-traded companies can be considerably less arduous. Perhaps the most complicated issue of all is valuing stock options and restricted stock that have been granted but haven’t vested yet.The current value of stock options and restricted stock will depend on numerous factors – including how far in the future they vest. This is easier to compute with restricted stocks, because unless the company goes bankrupt, the stock should have some value – unlike stock options which might have an exercise (strike) price that is greater than its market value (a condition commonly referred to as “being underwater”).Your divorce team will work out likely scenarios for the probable worth of stock options and restricted stock. Based on independent evaluations of a company’s potential and performance, it is be possible for a forensic accountant to predict, at the very least, whether these assets have value or not. If they do, the accountant can look into other factors in order to fine-tune that assessment as much as possible.
Can negotiation resolve a high-net-worth divorce case?
Because of the high cost of a trial, all divorce litigants should to try to resolve their conflicts through negotiation if possible. Although most high-conflict cases start out with litigation, most of them can be resolved once the discovery process is complete. Often that’s when the parties and their attorneys are satisfied that they have all of the information necessary to effectively negotiate a settlement. When parties settle their case out of court, they maintain a degree of control over the terms they will be obligated to comply with and can better tailor the settlement to meet their specific needs or desires.When parties are unable to settle, they subject themselves to a court determination. The judge decides their respective rights and obligations, and many times, neither party is entirely happy with the ruling. Of course, there can be times when one or more issues warrant the expense of a trial. That’s usually when the amount in dispute justifies the expense of a trial and the party and his/her lawyer believe that they have a good likelihood of success.
How do we prepare high-net-worth clients for divorce litigation?
Clients need to be well informed to help them prepare for divorce litigation and court. Professional responsibility dictates that attorneys keep clients informed about all aspects and phases of their litigation. Working with clients to define objectives and the process of achieving them is extremely important to courtroom preparation. Clients must understand the discovery process and depositions. Before each and every court appearance, I explain the purpose, what to expect, and what issues will be addressed that day to my clients. If my client has children, I make sure the client is aware that they may be parenting in a goldfish bowl, meaning that their child-related actions and decisions may be subject to court scrutiny.
What is Discovery, and when does it occur?
In a contested case, after one spouse files for divorce, the often torturous and tedious process of financial discovery begins. Each side may send the other lengthy lists of questions called “interrogatories”, which have been drafted by the lawyers and which must be answered under oath. Interrogatories are composed of questions about finances, assets, pensions, and similar financial issues. Through their lawyers, the spouses can also serve notices to produce documents such as bank statements, credit-card bills, receipts, tax returns, paycheck stubs, and the like. Unlike mediators and collaborative lawyers, litigators can also serve discovery subpoenas on third parties for this type data/documents. Usually, the attorneys will sift through the interrogatory answers and documents, and then question the spouses in person under oath at what is called a “deposition”. Third parties who have relevant information – such as business partners, bookkeepers, accountants, or other witnesses – may also be questioned at a deposition. A deposition takes place in the presence of a stenographer (a court reporter), who later transcribes what was said into a transcript.
Does it make sense for a business owner to offer to pay additional spousal maintenance instead of buying out their spouse’s interest in a family business?