Leveraging Your Expert in Drafting of Marital Settlement Agreements

Imagine you and your client have just spent months, maybe even years, attempting to negotiate a settlement in their matrimonial matter, and FINALLY, an agreement has been reached. The hard part should be over, right? Unfortunately, that may be far from the case.

While it may seem that the preparation of the Marital Settlement Agreement (“MSA”) is a straightforward process of memorializing the terms that the parties have spent months to years negotiating, the fact is “the devil is in the details.” Choice of terminology, references to specific calculations/methods (or omission of same), and a variety of potential pitfalls can, and have, caused misunderstandings and misinterpretations, landing the parties right back where they started – in court.

It goes without saying that the provisions memorialized in the MSA should be thoroughly explained to the parties in advance. What we often encounter, however, is that while the parties will agree to issues in theory, they often don’t perform a detailed review of the MSA, don’t ask questions, and, as a result, frequently get bogged down in the actual mechanics of effectuating the agreement. Additionally, we often see financial terms such as “net income” used in ways that may or may not be appropriate to the given circumstance. In these instances, if the MSA itself isn’t very clear…welcome back to litigation!

This article discusses different scenarios, but certainly not all, where vague or missing language in a MSA may lead to unforeseen complications down the road. In almost all of these cases, leveraging the services of the financial expert can be an invaluable resource.

Business Valuation

When one spouse owns an interest in a business, all or part of the business is considered part of the marital estate and may be subject to equitable distribution. In almost all of these instances, a business valuation, whether formal or informal, is recommended for several reasons. First and foremost, while the owner spouse will likely retain the business, the non-recipient spouse needs an understanding of what their equitable “share” of the business is worth to understand what they will receive.

Often, an MSA will reference the value of the asset received in lieu of the business interest but does not reference the business value itself. Why does this matter? It is quite simple. When the topic comes up in conversation, and the non-owner spouse thinks, “Wait, I didn’t get a piece of the business,” they may refer back to the MSA, a reasonable response. If the MSA states they received a brokerage account worth $50,000 instead, what conclusion do they draw? Does that mean the business was worth $100,000 under the presumption that all the assets were divided equally? The MSA should clearly state the actual percentage awarded and the valuation conclusion for the business. If factors impact the percentage awarded to the non-owner spouse, such as consideration for a pre-marital value, those factors should also be clearly explained. Regardless of the reason, the parties can agree to anything that works for them, but the terms should be explicitly referenced in the agreement so that the parties are prevented from having “selective memory” years down the road.

It should also be noted that some businesses have no value; they provide a job for the owner and nothing more. This does not mean the business should not be referenced in the MSA; rather, it should be noted that 1) the business was considered, but 2) it was determined to have no value and was therefore not considered in determining the marital estate.

Alimony/Income Determination

Determining alimony should be relatively straightforward in cases where one or both parties are W-2 wage earners. The challenge comes when a spouse is self-employed or has a more complex compensation structure.

If a spouse is self-employed, their income may come in the form of various expenses paid through the business, such as auto, credit cards, insurance, etc. They may own the building in which the company operates. All of these economic benefits need to be considered for alimony purposes. Additionally, recognition needs to be given to the fact that the business owner can potentially manipulate their income in the process of what is commonly referred to as “divorce planning.” An example would be a sudden decline in revenue that the owner attributes to external factors (competition, economy, etc.) when, in reality, they are simply working less. An accountant is frequently engaged in these cases to determine the business owners’ true economic benefit.

Now let us say one spouse receives a base salary as well as some combination of an annual bonus, performance incentives, or equity-based compensation such as stock options (“SOs”) or restricted stock units (“RSU”). In most cases, the only constant year-to-year is the base salary, as the other components of compensation are typically predicated on the employer’s financial performance and/or the employee’s annual performance review. Often, we see that alimony is comprised of two distinct parts: (1) a percentage of the base salary and (2) a percentage of the additional compensation (bonus/non-cash compensation) if and when it is awarded. While this appears relatively straightforward, there is a “wrinkle.” With equity-based compensation, many factors would render the awards as assets that would be considered available for equitable distribution instead of income. Additionally, there are circumstances where the award of non-cash compensation is a non-recurring event. All of these circumstances need to be reviewed and quantified in order to arrive at an agreement that is advantageous for both parties.

Equity-Based Compensation

This issue comes up so frequently that it deserves further discussion. It is imperative to understand the type of equity-based compensation, how it is awarded/granted, how/when it vests, and how it is ultimately received. We have seen instances where equity-based compensation was defined incorrectly in the MSA, leading to complications when facilitating equitable distribution. Further, it should be noted that the existence of a grant/award of stock options or RSUs does not guarantee receipt of the same, as these forms of equity-based compensation can be subject to both vesting schedules and forfeitures. If the recipient spouse’s employment is terminated prior to vesting, they cannot monetize the awards, and alimony or equitable distribution could be impacted. The MSA should include language that explicitly addresses these potential situations to avoid surprises in the years to come.

Conclusion

While accountants are often involved in the determination of business value and income, their experience and familiarity with the case can be a valuable resource when drafting the MSA and can minimize the potential for post-judgement disputes in the future.