Owners of closely held corporations, including family businesses, are often concerned that a member’s spouse may pursue or obtain shares in a divorce. Their unease is warranted. If shares are at issue in a divorce, the value of the company is at issue, and valuation litigation is often time-consuming, intrusive, and expensive, even for a third party. A member’s ex-spouse gaining an ownership interest may also pose problems, particularly in the case of family businesses. Because of these potential problems, as many businesses owners know, it is advisable to include terms addressing member divorce in the transferability and buyout provisions of the company’s operating agreement.
Illinois divorce courts have traditionally and prudently avoided property allocations that conflict with operating agreements, a fact supported by the lack of Illinois case law on the issue. The Illinois Appellate Court, Second District, recently addressed this issue and provided a degree of predictability to business owners, holding that a trial court abuses its discretion by ignoring reasonable transfer restrictions in an operating agreement when addressing the allocation of shares in a divorce.
In In re Marriage of Schlichting, 2014 IL App (2d) 140158, the wife owned shares, ironically, in the husband’s family’s quarry business, Rockton Rock, LLC. The shares were marital property (in her name, but, presumably, acquired during the marriage). The Rockton Rock operating agreement contained a transfer provision barring any member from transferring any interest in Rockton Rock without the consent of all members. Id. at ¶ 5.
The operating agreement also included within its buyout provision terms for valuing Rockton Rock in the event of a member’s divorce. Id. at ¶ 53. Specifically, the agreement provided that the buyout value would be the greater of the company’s accountant’s valuation and the court’s valuation, and that the shareholder-spouse would pay the difference to the company. In other words, upon the court’s order, the company would buy the shares from the member-spouse at the litigated value, and the member-spouse would be required reimburse the company for any overage beyond the company’s valuation. See id. at ¶ 7. The only valuation presented at trial was the company’s accountant’s. The husband did not present a competing valuation. See id. at ¶ 54.
Despite the operating agreement’s transfer restrictions and the buyout provision, the trial court ordered the wife to sell her shares to the husband, without the unanimous consent of the other members. See id. at ¶ 23, 47. On appeal, the court noted that “no Illinois case requires a court to distribute marital property in accordance with an operating agreement…” Id. at ¶ 60. It also found that Illinois appellate courts had not reached holdings regarding conflicts between divorce orders and operating agreements. See id. ¶ 66.
Because the operating agreement barred the transfer of shares to the husband and provided a buyout provision permitting a court-ordered valuation and distribution, the appellate court held that the trial court abused its discretion by ordering the transfer of shares. See id. ¶ 69.
The Schlichting court could have reached the same result even if the buyout provision for valuation did not exist. The trial court would have had the ability to effectuate a fair allocation of marital property by valuing the property and ordering the wife to sell, or by allocating an offsetting amount of other property to the husband, regardless of the transfer restrictions. The buyout provision in Schlichting did not impose a value on the court or the non-spouse. In fact, the buyout language disadvantaged the member-spouse because it incentivized the company to value low and obligated the member-spouse to make up the difference. Given these circumstances, the appellate court was correct to reverse the court for disregarding the operating agreement and provided precedence supporting such agreements in future cases.