Many couples in Hong Kong hold interests in companies that own landed properties or other investments. When the couples divorce, there are various ways in which corporate interests can be dealt with.
This article highlights some key considerations that divorcing couples should note if they desire to transfer their corporate interests in divorce proceedings.
Methods of division
Rearranging corporate interests for a divorcing couple is not as simple as transferring one’s shares to another. There are many factors that need to be carefully considered before making such re-arrangement to prevent contentious issues from arising. The most effective way for such re-arrangement very often depends on the specific situation on a case-by-case basis. For example, if a company is jointly owned by a divorcing couple and each spouse wishes to keep a certain part of the business post-divorce, then it would be advisable to incorporate a new company, and transfer part of the business to the newly set-up company. In such case, it is important to take into account the Transfer of Businesses (Protection of Creditors) Ordinance (Cap. 49) when dealing with the existing business’s creditors. This would ensure that the assets and liabilities of the business are divided in accordance with the parties’ wishes.
Alternatively, where a spouse does not wish to keep an interest in the company, then the spouse who elects to keep it should opt to pay the other spouse equality monies for there to be a fair division, either by making a lump sum payment or through periodic payment to the other from the company’s assets and/or profits if it is a running business. If the paying spouse has liquidity issues, he or she could consider obtaining a director’s loan from the company or seek for other forms of financing in order to pay the lump sum, e.g. by pledging the shares to a bank.
Lastly, if neither spouse wishes to keep the corporate interest, the corporate interest could be sold. It can be stated in the divorce settlement that the sale proceeds will be held by the solicitors who are appointed in the sale process and will distribute the proceeds (in the desired proportion) to the parties directly in order to avoid argument. If no sale of business is possible, parties may dissolve the company and distribute the remaining assets.
Mortgage or charge over shares
Akin to our previous discussion [link again] on concerns associated with transferring real estate, similar concerns are present when it comes to transferring corporate interests. It may be that shares in the company have been pledged as part of a loan facility, or where the company is a property holding vehicle, its shares may have been mortgaged to the bank.
In such situations, it is important to take note of the following considerations:
- Who shall be responsible for the repayment of the outstanding loan to the lender;
- Who shall bear the costs of the discharge and redemption of the existing mortgage;
- Whether the facility requires refinancing; and if so, whether alternative or additional collateral will have to be provided; and
- What alternative arrangements should be made if the lender refuses to refinance or transfer the facility; and if so, whether it will cause financial or cash flow issues.
Stamp duty liability
There is a misunderstanding that no stamp duty is chargeable on a share transfer pursuant to a divorce order granted by the Family Court of Hong Kong. In fact, even if the share transfer is ordered by the Court, the parties are liable to payment of stamp duty, which is currently charged at 0.26% of the considered amount or the net asset value of the shares being transferred, whichever is higher. The amount payable will depend on the company’s value (see discussion below), but not the stated consideration on the instrument effecting the transfer. Parties should agree on who will bear the stamp duty when they are discussing the terms of the divorce settlement, or how it should be apportioned.
If the company holds real estate interests, instead disposing the property directly, parties should consider transferring ownership of the company in order to take advantage of the lower stamp duty chargeable on share transfers as opposed to property conveyances.
As stamping is a lengthy process, especially when the stated consideration is not the full market value of the shares, the time needed to complete this process should be factored in; particularly if the company is a running company with various business and assets.
It is also worth noting that if the company previously enjoyed stamp duty relief under section 45 of the Stamp Duty Ordinance (Cap. 117) by reason of a transfer between associated companies, a share transfer may result in a cessation of association relationship, and the parties may be liable to pay back the stamp duty previously exempted.
Pre-emption rights and transfer restrictions*
Pre-emption rights and transfer restrictions would cause a practical issue. For example, if the divorcing wife holds shares in a private company, rather than transferring them to the husband under the settlement agreement, under a pre-emption rights mechanism, the wife must first offer the shares to other company shareholders. The share transfer to the husband could only be done if all of the shareholders agree to not exercise their pre-emption right. Conversely, it is possible that another shareholder may decide to exercise his/her pre-emption right and take up the offer, and purchase the shares from the wife. This would create an undesirable situation even though the wife would be able to cash-out her shares in question, as this would not fulfil the intended property division arrangements under the settlement.
In such a situation, prior to concluding a divorce settlement, it is suggested that discussions should be had with other shareholders in the company to obtain a waiver of their pre-emption rights, or to remove the transfer restriction mechanism all together. This would allow for a smoother transfer of shares from one spouse to another, without the possibility of another shareholder thwarting the parties’ efforts to reach a settlement, especially when a complex family business structure with senior family members as shareholders is involved.
(* Pre-emption rights are rights which require the shareholder who is transferring his/her shares (the transferor) to first offer their shares to other shareholders in the company before selling the said shares to third parties outside of the existing membership of the company. It may be coupled with a transfer restriction, which prohibits transfer of shares to persons other than existing members of the company. It is common for these restrictions to be present in the company’s memorandum (constitution) or pursuant to a shareholders’ agreement. )
Valuation
Determining a company’s value is often an important aspect when negotiating settlement in divorce proceedings. It is important to know the value of the company in order to ascertain the size of the matrimonial pot for division. The divorcing couples should try to agree on a valuation of the spouse’s shareholding in the company, failing which would then require a formal valuation of the corporate interests by appointing a single joint expert, who is usually an accountant or surveyor.
However, there may be difficulties in valuating a spouse’s shareholding if the spouse holding the shares is not concurrently a director of the company, or if other shareholders in the company do not wish to allow the company to be valued. As such, in order to inspect the books and accounts of the company for valuation purposes, it may be necessary to apply to the court under section 740 of the Companies Ordinance (Cap. 622) for an inspection order.
Continued co-operation
In some instances, divorcing spouses may wish to continue co-owning or running their company together despite their divorce. We would recommend that these couples enter into a shareholders’ agreement to clearly delineate each of their shareholders’ rights and responsibilities in relation to the company. That way, it would help facilitate future co-operation and avoid arguments or deadlock situations regarding the management of the company.
In summary, there are a myriad of concerns that divorcing couples should take note of when considering a financial settlement involving corporate interests. Our teams of corporate and family lawyers at Withers are most happy to provide further advice on this topic.
For those interested in knowing more about the transfer of real estate in a divorce settlement, please refer to our previous article .
For further information, please contact:
Polly Chu, Partner, Withersworldwide
polly.chu@withersworldwide.com
Jocelyn Tsao, Partner, Withersworldwide
jocelyn.tsao@withersworldwide.com
