Protecting your share of shares: The importance of cohabitation agreements/marriage contracts
A cohabitation agreement/marriage contract is a contract setting out what would happen in the event a common law or marriage relationship ends.
These agreements can be drafted narrowly in scope (dealing with specific property or assets) or more broadly. It is important that they be tailored to the unique needs and circumstances of the parties involved. These agreements give certainty to parties to know how assets, debts and property will be dealt with on separation and can help to avoid litigation.
These agreements can be made before or after cohabitation or marriage. Section 53(2) of the Family Law Act states that if the parties to a cohabitation agreement marry each other, the agreement shall be deemed a marriage contract. It is important to consider a cohabitation agreement/marriage contract as they can obviously save a great deal of time and money down the road.
Without an agreement, the law entitles a spouse to a claim to interest in all of their spouse’s property acquired during the course of the relationship/marriage.
Business interests are included as property when calculating a spouse’s net family property for the purposes of calculating the equalization payment. This includes the increase in value of a business in which a spouse owns shares or otherwise has an interest.
In the event there is no cohabitation agreement or marriage contract on separation, a spouse’s interest in a business must be valued and included in the property calculation. This often requires the assistance of an expert such as a certified business valuator. Further, the company itself often may become embroiled in the family law proceedings either with disclosure requests (often of confidential/sensitive information) or as a party to the proceeding.
A cohabitation agreement/marriage contract allows parties to contract out of these property division rules established by the Family Law Act. These agreements provide a level of certainty and peace of mind in knowing how property is to be dealt with if the relationship ends or a spouse dies. They can protect family heirlooms by keeping them out of “family property”. They often are used to help protect a family business.
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Many shareholder agreements require shareholders to have cohabitation agreement/marriage contracts in place to protect the assets of the company.
Without an agreement, where a spouse does not have the funds to pay the equalization payment owing, the court may order the transfer of shares, even despite a shareholders agreement prohibiting such transfer. As a result, with no agreement, a company’s assets may be vulnerable to dilution in the event of a separation, and may result in unintended and undesired “partners” to the other shareholders.
In order to minimize or eliminate disputes, cohabitation agreement/marriage contract should stipulate how the parties’ property will be dealt with in the event of the breakdown of the relationship or the death of a spouse. Those agreements can:
- exclude or include business interests from the parties’ net family property for the purposes of equalization;
- exclude or include business interests from the parties’ net family property for the purposes of spousal support;
- waive a spouse’s right to claim an interest by way of constructive trust;
- require a party to sell back any shares or business assets acquired by way of equalization;
- prohibit a party from forcing an asset sale or transfer to satisfy a judgment;
- establish a method to value those business interests and assets in the event of separation (i.e. choosing a person or process to value the business);
- establish a dispute resolution process in the event of a dispute over the interpretation of the agreement (i.e. mediation/arbitration vs. the court system)
A cohabitation agreement/marriage contract is important to ensure the terms of a shareholders agreement are binding on the spouses of shareholders. The cohabitation agreement/marriage contract should be consistent with the shareholders agreement to prevent reprisal by the company and other shareholders. (See post “Common provisions of a family shareholders agreement” for more details).
These principles also apply to partnerships and other forms of business interests.
It is important to have lawyers involved in the preparation and drafting of the agreement to make it less likely the agreement, or provisions in the agreement, will be set aside later by a court, and to ensure the parties understand the agreement. It is obviously more challenging for a spouse to allege they did not understand the agreement, when they had a lawyer to provide legal advice during the process.
In Ontario, a court may set aside a cohabitation agreement/marriage contract where there was:
- lack of proper financial disclosure (whether intentional or not);
- a lack of understanding of the nature or consequences of the contract; or,
- duress, fraud, undue influence or mistake.
Further, if the contract itself is unconscionable – is so egregious that it “offends the court’s sense of decency” – then the law of contract would permit such a contract to be set aside.
In the case of Stupka v. Stupka, 2012 ONSC 1133, the husband failed to produce financial statements, balance sheets, shareholder loan accounts, income tax returns or other documents confirming of his assets, liabilities, income or expenses prior to signing the agreement. Further, he failed to disclose that the company owed him $381,000 at the time or the value of property held by the company. In these circumstances, the court held that the agreement was invalid and unenforceable as a result of the husband’s failure (albeit unintentional) to disclose his significant assets, debts and liabilities when the contract was made, and the fact the wife did not understand the nature and consequences of the contract when she signed it. The husband was, as a result, required to account for his business in his net worth for the purposes of separation.
Full financial disclosure and independent legal advice help to guard against this result.