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06 Dec 2010 09:00
There’s only one thing more fascinating than a celebrity marriage, and that’s a celebrity divorce. Particularly when it’s messy, vituperative and, yes, expensive.
But it’s when we think of divorce as a corporate risk that it takes on another whole dimension and provides cautionary tales to give CEOs nightmares.
Not to mention how the hits a company takes may affect the average employee.
Take Elon Musk’s divorce from his wife Justine, for example.
Musk ploughed most of his own money into Tesla, off the back of his sales of Zip2 and PayPal to Compaq and eBay respectively. Tesla has been his ‘baby’ in a certain sense—his electric car venture has consumed him. He netted $48-million in income investments between 2005 and 2008, which were sunk back into Tesla and SpaceX, a space exploration concern. But court filings brought his cash-flow problems to light, revealing he was living off personal loans from friends since October 2009.
Tesla also had cash-flow problems and had borrowed from the United States government (a cool $465-million in low-interest loans) through a Department of Energy loan programme.
At the time, Tesla was looking to go the IPO route—but the Securities and Exchange Commission (SEC) pored over Musk’s personal financial affairs, asking whether Tesla was forthright enough in its filings regarding how his impending divorce would affect the company’s bottom line. Tesla was relying heavily on Musk’s continued financial interest in his entrepreneurial venture, reimbursing him for his private jet flights in return, as well as awarding him 6,7-million stock options in December 2009.
The situation looked liked this. Musk’s shares in his company, Tesla Motors Inc, were held in private trust—but his wife sought half his stock in Tesla and 5% in his stake in SpaceX as part of a divorce settlement. If Musk’s shares had been declared marital property, he would not have been able to sell his holdings without permission from his ex-wife. If he lost a large shareholding, Tesla would be in default of the Department of Energy loan and the company’s IPO could have been in jeopardy. (As it happens, the IPO went ahead—Tesla raised more than $226-million.)
Justine, a fantasy novelist, went into some detail about the divorce on her blog (//moschus.livejournal.com), stating: “For those who want to know the extent of my golddigging, this is what I asked for, from my ex-husband and the father of my five children Elon Musk, who is a billionaire—albeit with cash/liquidity issues, which I would work with him to work around—and utterly brilliant.
During divorce proceedings, Justine contended that the postnup Musk had asked her to sign could be dismissed as fraudulent as the value of his X.com stock was millions of dollars more than he had reported on the postnup (a postnup, unlike a prenup, requires complete financial disclosure because of ‘marital fiduciary duty’).
Musk eventually won the case ‘due to a technicality’, Justine wrote.
This, then, is how corporate divorce can wreak havoc. The personal goes public and legal wrangling can affect shareholdings—and investors.
What shares and perks are worth
“Few shareholders would consider that the divorce of its CEO could affect their investment, but the risk exists,” says Colm Tonge, national leader of PricewaterhouseCoopers’ Disputes practice. “A difficult scenario which has emerged in the US is where the divorced spouse could be awarded shares in a divorce settlement introducing risks of tactical voting, boardroom battles and takeovers. A company can be in breach of debt covenants if a key shareholder’s stake is reduced.”
Another key issue is the valuation of shares or share options. In Musk’s case, he has little cash but his net worth is inextricably linked with the future success of the business. In many cases, it takes a public listing to unlock these.
“This holds true of BEE transactions in South Africa, where it is normal for shareholders to be locked in for a period of time,” says Tonge. “In divorce cases, there needs to be a division of assets. One of the most contentious issues is often a spouse’s interest in unlisted businesses or entities in which he or she is integrally involved. Valuation of shares or share options, vested or not, is often a major argument.”
Typically, the ‘breadwinner’ will argue that options that have not vested are worthless and cannot be accessed or turned into cash at the date of divorce. But share options usually have a ‘future value’, says Tonge, or they would not provide the kind of incentive for which they have been designed.
Tonge says the Black-Scholes Option Pricing Model is often used to calculate the value of share options. But calculations can vary widely, depending on the assumptions used, so this can be a lucrative battleground for lawyers. Gone are the days of going after assets like a house or a car—‘soft’ assets like unvested stock options and pension benefits are now brought to the table.
Another international headline-making case was the divorce of Jack and Jane Welch (Beasley). The founder of General Electric (GE) found himself outplayed by his mergers-and-acquisitions lawyer spouse, who divorced him after 14 years of marriage. When Welch drew up a prenuptial agreement, Beasley insisted on a 10-year time limit to its applicability, so she left the marriage with about $180 million.
Beasley’s attorney published an affidavit revealing a retirement package that allowed Welch unfettered use of corporate jets (worth more than $290 000 a month), a limousine, a cook and country-club memberships. The Securities and Exchange Commission duly took a closer look at the perks.
“A reasonable shareholder would certainly wonder how these expenses serve the organisation, assuming that is was aware of them in the first place,” says Tonge. “Potential shareholders may shy away from organisations that are perceived to put the lifestyle of management before the company’s interests. And how are those ‘perks’ to be valued?”
When it comes to divorce, settlement is the one thing that can make it all go away, but to achieve that seems well-nigh impossible in some cases. Forensic accountants are called in to examine tax returns, accounting records, invoices, contracts, financial projections. They search for hidden assets or hidden income. They perform business valuations and examine tax consequences.
“A major issue in divorces of the rich is offshore assets,” says Tonge. “Most large estates will include some allegations of property and bank accounts in other jurisdictions. It was hoped that the South African tax amnesty of 2003 would minimise these issues but the reality is that if the assets were undeclared and undetected to that point the temptation to keep them overseas was real.”
In fact, it is difficult for forensic auditors to trace overseas assets without knowing where to start looking. Periodically topped up overseas funds and a transfer of assets after divorce proceedings have been instituted can be detected. But if assets have been lying untouched for years they may remain hidden.
“Once identified, such assets can be ordered by the Court to be repatriated,” says Tonge.
Liza Segal, an advocate specialising in divorce and family law and a co-founder of Ad Idem, a family and divorce settlement mediation company, says that, in the majority of divorces in South Africa, the claim for a portion of the other’s estate is a monetary claim and not a claim for a particular asset, that is, shares in a company. As such, the settlement agreement should not affect the other shareholders. Unless the parties specifically agree that the wife will acquire shares in the company in lieu of money, the wife will not become a major shareholder in the company.
What may affect shareholders in a company, or cause shares to decrease in value, is public perception regarding the stability or integrity of the particular director who is involved in divorce litigation. Usually, the company is not a direct party to the proceedings and, in the absence of the company being joined as a party, the court cannot make orders binding it.
Segal’s business partner, Deanne Kahn, says that the only way around a messy, expensive, litigious process is through settlement mediation. “The mediator provides guidance for the couple on the anticipated range of likely court outcomes and helps them to reach a mutually acceptable resolution,” she says. In other words, the outcome will be the same whether the matter goes to court or not—but the process will be less protracted, less costly and, perhaps most importantly, not as disruptive to business. “The incessant flow of applications and counter-applications, pleadings and affidavits can be avoided,” says Kahn.
Of course, both parties have to want to settle. By all accounts, both Musk and Welch resisted and the escalating hostilities played out on the pages of newspapers around the world. Embarrassingly, they’re still on the internet for leisurely inspection. And although we might feel a certain schadenfreude seeing the cheating wealthy come unstuck in a way that smacks of karmic justice, we should also spare a thought for the employees, families and shareholders who stand to lose just as much, in their own way, when corporate divorce turns ugly.
How can you find out where your partner’s wealth is kept?
Kahn says the first step would be to extract as much information as possible on a voluntary basis by requesting details of all assets, both movable and immovable, locally and abroad. In the event that this proves insufficient or unsuccessful, it is possible to subpoena third parties to produce documentation and to testify at court and to compel the other party by way of court order to produce the desired documentation.
Also, it is not unusual for parties to appoint a forensic auditor in complicated matters, or in matters where large estates are involved, to investigate the extent of the opposing party’s wealth and to produce a forensic report containing details of that party’s estate.
Geraldine Macpherson, a legal marketing specialist with Liberty, says that many wealthy business owners transfer their assets (including their shareholding) to trusts and set up multiple trust structures, to confuse matters more. If the soon-to-be-ex spouse can show that the trusts were not being correctly administered and used, she can potentially lay claim to the trust assets.
“In the case of Badenhorst v Badenhorst 2006(2)SA755(SCA), Mrs B, on divorce, was granted a share in the trust because the court found that Mr B basically ran the trust as if it were an alter ego of himself—he used the trust assets as if they were his own, the other trustees were not actually consulted or involved in the administration of the trust and for all intents and purposes the trust was merely a sham,” says Macpherson.
“From what I see in practice, most people who establish trusts do not run them correctly and in fact incorrectly consider the trust as their own personal property. If the spouse is a co-trustee, she will have a good idea of whether she was actually ever consulted on any trust matters and whether her input was actually given due consideration. If not, the information can be more difficult to come by, but a sharp attorney would be able to get his or her hands on it—records of trustee meetings should be held, trusts need to have separate bank accounts and so on.”
Macpherson says that trusts do not necessarily provide the protection that one thinks they do. She also says that if a spouse is married in community of property, she should have given her consent for assets to be moved into a trust—if this was not the case, she has a right of recourse and may be entitled to share in the trust assets.
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