Introduction

Divorce is rarely simple, and when a family-owned business is involved, the process can become even more complex. Because a business is a very often a piece of marital property, it is subject to the same equitable division rule as the furniture or television.  However, it is not furniture and its division is much more complicated.  This is especially true when the parties are both actively working in the business.  However, just because it is complicated does not mean that there is no guidance on handling this important asset.  In Tennessee, the division of a business in a divorce is governed by specific statutes and an evolving body of case law.  So, how do Tennessee courts divide a business in a divorce?

Step 1: Classify It

Tennessee’s equitable distribution scheme for marital property always starts with the same first step, classification.  Is the property marital or separate?  If it is separate, you are done (sort of).  If it is marital, go to step 2.  Here’s a helpful hint, you will almost always go to step 2.

Tennessee law defines marital and separate property at § 36-4-121.  Marital property is most assets which were acquired during the marriage.  Separate property generally consists of assets owned before marriage or received as gifts or inheritances. However, when a spouse’s efforts or marital funds have contributed to the growth or operation of a previously separate piece of property, such as a business, that business (or its increased value) may be deemed marital property.  This is why while important, step 1 almost invariably leads to step 2.

Step 2: Value the Business

Once the court determines exactly what of the business is marital (the whole thing or its increased value), the next step is valuation.  Tennessee courts often rely on expert testimony, such as forensic accountants or business appraisers, to establish the fair market value of the business. The court considers factors such as tangible assets, goodwill, debts, and the business’s earning potential.  Powell v. Powell, 124 S.W.3d 100 (Tenn. Ct. App. 2003), is a good example of case showing the importance of obtaining a good business valuation and highlights the importance of that expert valuation in the court’s determination of the value of the business.  In our justice system, it is very important that you present a solid business valuation from an experience professional.  It is normally not enough for a party to simply testify to what he or she thinks the business is worth.

Step 3: Divide it

T.C.A. § 36-4-121(c) outlines the factors courts use to equitably divide marital property, including the duration of the marriage, each spouse’s contribution to the business, and the economic circumstances of each party.  Tennessee is an “equitable distribution” state, meaning the goal is a fair—not necessarily equal—division of property.

A business, in many respects is like a child.  Courts are normally not going to go King Solomon on a business and divide it.  Like dividing a baby, dividing a business can be detrimental to its continued existence.  Instead, it is more common for one spouse to be awarded the business, with the other receiving an offsetting award of other marital property or a monetary payment for their share of the value of the business.  Guidance on how courts deal with these issues can be seen in Owens v. Owens, 241 S.W.3d 478 (Tenn. Ct. App. 2007).  In that case, the court awarded the business to the husband and offset the wife’s share with other assets.  It is also important because it highlights the trial court’s ability to use multiple valuations and come to its own conclusion.  As the appellate court said, “placing a value on a…business is not an exact science.   In the face of conflicting opinions regarding the value of a marital asset, the trial court may place a value on the asset that is within the range of the values presented by the competent evidence.”

Goodwill and Professional Practices

A key issue in valuing family businesses is whether “goodwill” should be included in the business valuation. Goodwill represents the intangible value of the business’s reputation, client base, or the personal reputation of a spouse in cases of professional practices (e.g., law or medical offices).  Courts are uniform that while business goodwill can be properly characterized as part of the value of the business, personal goodwill is not a marital asset that is subject to valuation.  In Smith v. Smith, 709 S.W.2d 588 (Tenn. Ct. App. 1985), the court distinguished between enterprise goodwill (which is a marital asset) and personal goodwill (which is not subject to division).

Protecting the Business During Divorce

Tennessee courts will expect the parties to take steps to protect their business in a divorce, especially if that business is a primary income source for one or both parties.  Additionally, parties can take steps before and during divorce proceedings to protect a business.  These may include prenuptial agreements, clear documentation of ownership and contributions, and careful separation of business and personal finances.  However, once divorce is filed, courts may issue orders to prevent the dissipation or transfer of business assets.

Conclusion

The division of a family-owned business in a Tennessee divorce is governed by statute as interpreted by the courts.  Courts seek a fair division based on the unique facts of each case, considering contributions, value, and the best interests of both parties.  Anyone facing a divorce involving a family business should consult with a qualified Tennessee attorney to ensure their interests are properly represented in this complex area of law.