By Ladd Hirsch[1]

Spousal consent provisions are commonly found in the governance documents of private businesses, e.g., corporate bylaws, limited partnership and LLC agreements.  Private company owners include these consent provisions in their agreements, because they do not want to find themselves suddenly stuck with a new business partner when one of their co-shareholders, partners or members goes through a divorce.  Whether the spousal consent provision will hold up in court when challenged by a spouse claiming unfair treatment, however, depends on a number of factors, and the frequent use of these provisions provides no safe harbor.

This post examines the legal considerations a court will focus on when a spousal consent provision is challenged in a divorce proceeding and also considers issues that arise when the company seeks to enforce the provision against a divorcing spouse.  We conclude the post by offering suggestions for drafting a more effective (enforceable) consent provision.

The Purpose of a Spousal Consent Provision

Spousal consents in company documents do not show up by accident.  The company’s owners insist on including consent provisions to prevent a situation in which they inherit a new business partner involuntarily when a divorce is filed by a co-owner.  The consent provision is therefore triggered when one of the company’s owners files or becomes subject to a divorce action.  Once it is triggered, the consent provision generally requires the spouse of the divorcing owner to promptly sell his/her interest in the business to the company on prescribed terms.

In this post, we refer to the “non-member spouse” as the spouse against whom the consent provision is being enforced after the divorce action is filed.  The non-member spouse may challenge the enforceability of the consent provision if he/she concludes that the terms governing this mandatory buyout are not fair to him or her.  For example, if the consent provision requires the non-member spouse to transfer his or her ownership interest to the company for a price far below its fair market value (not uncommon), the non-member spouse is likely to consider ways to avoid or rescind the consent provision.

Key Elements of Binding Consent Provision

Divorce courts are courts of equity, which means the family law judge has discretion to divide community property in a way deemed to be equitable, just and right.  The court’s discretion plays a significant role, because the factors the judge considers in voiding a spousal consent provision are the same in all cases, but the outcome may be different depending on the party who is seeking to enforce the provision.  Specifically, the court will consider whether the company is seeking to enforce the spousal consent provision or whether a member spouse is invoking the consent provision against the non-member spouse to achieve a one-sided result.

The critical factors the divorce court will consider in deciding whether to uphold a spousal consent provision when it is challenged by the non-member spouse are: (i) whether full disclosure of all material information was provided to the non-member spouse, (ii) whether the non-member spouse provided knowing consent, (iii) whether the non-member spouse was subject to duress in member the provision and (iv) whether the specific terms of the provision are unconscionable.  Each of these factors is reviewed below.

  • Full Disclosure by Requesting Spouse

In discussing the full disclosure element, it is important to note a critical legal aspect of the marital relationship.  Specifically, spouses owe each other a fiduciary duty in all of their joint business dealings during their marriage (this duty does end when a divorce proceeding is filed).  In the specific context of a spousal consent provision, the member spouse who requests the non-member spouse to sign this provision at the time the member spouse is acquiring an ownership interest in a company, the member spouse must fully disclose all material information the non-member spouse needs to make a fully informed decision as to whether to sign the consent provision.

In most cases, the member spouse knows much more about both the company and the likely financial outcome when the consent provision is enforced.  Therefore, in most cases, the member spouse cannot argue successfully that the non-member spouse just needed to read the agreement to become fully informed.  A “just read the document” defense will not work when the member spouse has financial, operational, or other material information regarding the company not known by the non-member spouse.  One of the key items that the member spouse is required to disclose to the non-member spouse  is the specific value/amount that the non-member spouse is likely to receive from the company when the consent provision is triggered at the time of the divorce.

  • Consent Must Be Freely Given

The need for the spousal consent to be provided by the non-member spouse on a voluntary basis and without duress or coercion may seem self-evident, but this element must be viewed in the context of spousal consent provisions.  In many cases, the spousal consent provision appears at the end of the agreement or in a separate attachment.  As a result, the member spouse may ask the other spouse to simply sign the consent provision on the final, or separate, page, but without either insisting or suggesting that the non-member spouse take the time to actual read the entire agreement.

Once a divorce action is filed, there is a good chance that the non-member spouse will contend that he/she did not have the opportunity to review the entire agreement and was given only the consent provision to sign.  The upshot is that if the non-member spouse was not given the opportunity to read the entire document, this will significantly bolster the non-member’s lack of consent defense to the validity of the consent provision.

The non-member spouse’s defense of coercion to the enforcement of a consent provision is generally not as compelling as the lack of consent argument. But, when the facts show that the member spouse engaged in threatening, coercive or other types of abusive conduct toward the non-member spouse, that evidence could be held sufficient to bar enforcement of the consent provision.

  • Consent Provision Must Not Be Unconscionable

As noted, in a divorce proceeding, the family law court has discretion necessary to issue a just and right division of the couple’s marital property, including their ownership interest in private companies.  A consent provision that provides one spouse with a dramatically different financial outcome at the time of their divorce will thus be met with a high degree of skepticism by a divorce court and may be deemed to be unconscionable.  For example, a consent provision that provides that the non-member spouse is required to sell his/her interest for a low ball price when a divorce action is filed while the other spouse is permitted to keep his/her ownership interest will likely not pass muster with the court.

The court may permit the non-member spouse’s community property ownership interest in the company to be sold for a low-ball price and also deprive the non-member spouse from participating in the business after the divorce.  In this event, however, the court can address this inequity favoring the member spouse by making a much larger (disproportionate) award of other community property to the non-member spouse.  An additional way the court may handle this would be to place the interest held by the non-member spouse in a constructive trust.  In this scenario, the spouse who originally owned the business interest in the company would retain the interest in his/her name, but would hold the stock in a trust for the financial benefit of both spouses.

  • Spousal Consent May Be Enforced by the Company

This post has focused to this point on situations where the member spouse was seeking to enforce a spousal consent provision against the non-member spouse, but in many instances, the company (also a party to the agreement) has the right to enforce the consent provision against the non-member spouse.  When the company seeks enforcement of a consent provision, it may not be in a family law proceeding, but whether or not the forum is a family court, if the terms of the provision are based on reasonable, legitimate business concerns, the consent is likely to survive judicial scrutiny.  Another factor in the company’s favor is that the company does not owe a fiduciary duty to the non-member spouse and therefore has no obligation to make full disclosure of material information regarding the company or the consent provision.

In an action by the company to enforce the spousal consent provision, the non-member spouse can still argue that the provision was obtained without his/her consent or that it was obtained coercively.  These defenses face an uphill battle in court, however, for two reasons.  First, in most cases, the company had no direct contact with the non-member spouse regarding the consent provision and did not engage in any improper or coercive conduct toward that spouse.  Second, a spousal consent provision is a contract term, and a court is likely to conclude (i) that the company is entitled to the benefit of the bargain it made with the non-member spouse as set forth in the agreement, and (ii) the consent provision should be upheld so that company (and the other owners) are not required to take on a new business partner on an involuntary basis.

In most cases, based on these factors, the court will permit the company to enforce the spousal consent against the non-member spouse and will deal with any financial disparity this causes when the court exercises its discretion in dividing the couple’s community assets.

Conclusion – Creating a Spousal Consent Geared For Judicial Challenge

Whether a spousal consent provision will be upheld when challenged by the non-member spouse depends on a number of legal elements and the specific facts of each case.  If the brief form of the standard consent provision is revised to include several changes and specific representations by the non-member spouse, however, these revisions will go a long way in helping to surmount a legal challenge to the provision.  The company and the member spouse will therefore want to consider making the following revisions to the consent provision and requiring the non-member spouse to make the following representations when he/she signs the consent adopting the bylaws or the terms of the limited partnership or LLC agreement:

  • Provide a plain language description of the consent that the non-member spouse is providing in the bylaws or agreement, along with a similar description of the business reasons that justify the need for including this provision in the document.
  • Include all of the following representations by the non-member spouse:

-The non-member spouse has reviewed and understands the entire agreement, including the manner in which the spousal consent can be triggered in the event of divorce (the non-member spouse should be required to initial each page)

-The consent by the non-member spouse is fully voluntary and was made without being subject to any pressure, compulsion or duress of any kind

-The non-member spouse has had the right to request information from both the Company and member spouse, but the non-member spouse has not requested and does not need any additional information that was not provided to make an informed decision

-The member spouse has had the opportunity to retain independent legal counsel to review the consent and the agreement before signing (if no counsel has been retained, the non-member spouse should represent that he or she has chosen not to have the document reviewed by counsel)

-The non-member spouse has independently determined that this consent is a fair, reasonable provision based on the due diligence the non-member spouse has conducted, including information regarding the value that the non-member spouse expects to receive at the time of the divorce

-The non-member spouse is not relying on any other promises, inducements or consideration from or by the company or the other spouse that are not fully and expressly set forth in the agreement

These suggested changes to the spousal consent provision provide a measure of protection to the company and member spouse if the provision is challenged in the future.  While these changes to the provision, including representations made by the non-member spouse, do not guarantee that the provision will be upheld, they fundamentally enhance the arguments made to the court.  In sum, these suggested changes to the spousal consent provision will make it much more difficult for the non-member spouse to invalidate the consent provision in a later divorce action or in any proceeding by the company to enforce the provision.

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[1] With thanks and appreciation to Kevin Segler, family law counsel with Koons Fuller, P.C., whose thoughtful comments and critique provided valuable guidance regarding the legal issues reviewed in this post.