Family Law & Business Owners with Heather Hansen | E023
How family law impacts business owners and how to plan for it.
In this episode of Financial Planning for Canadian Business Owners, Jason Pereira, award-winning financial planner, university lecturer, and writer, talks with Heather L. Hansen, Lawyer and Partner at Martha McCarthy & Company. Heather L. Hansen talks about family law and its impact on business owners, the legal ramifications of marriage and separation, and the myths to be aware of surrounding both of those instances.
Episode Highlights:
● 01:05 – Heather L. Hansen explains her background in family law.
● 03:42 – What are the tensions between family law and contract law?
● 06:11 – How does a divorice from a business owner differ from a regular conventional employee?
● 16:08 – What happens when some of that income from the business may not be fully reported?
● 22:27 – Get clear accounting on what your assets are
● 25:30 – Why is the family home different in family law?
● 30:38 – You can enter into a domestic contract that is not in contemplation or during a marriage.
● 37:31 – Heather L. Hansen’s ‘marriage contract mantra’ is to keep them as simple as possible and to do as little as possible in the contract.
● 41:37 – Heather L. Hansen discusses the class of excluded assets under the family law act.
3 Key Points
1. Value doesn’t equal fair market value and value doesn’t necessarily equal
some prior indicator of value.
2. In family law, division of property turns to the value of the business and the
obligation to equalize it.
3. In family law, child support and spousal support are based on income.
Tweetable Quotes:
● “I am a family lawyer. I practice in Ontario. I’m a certified specialist in family law and what that means is that it occupies the totality of my practice. I’ve been practicing for just over 12 years now.” – Heather L. Hansen
● “One of the areas that I’ve developed a specialty in is the intersection of family law and business, and how partially business owners are impacted during a separation process.” – Heather L. Hansen
● “People should consult often and early with family lawyers, particularly within their corporate life, and there are things that we can do. There are strategies and there are approaches we can do. But it is limited.” – Heather L. Hansen
Resources Mentioned:
● Facebook – Jason Pereira’s Facebook
● LinkedIn – Jason Pereira’s LinkedIn
● FintechImpact.co – Website for Fintech Impact
● jasonpereira.ca – Website
● Linkedin – Heather L. Hansen’s Linkedin
● mccarthyco.ca – Website for Martha McCarthy & Company
● Heather@McCarthyCo.ca – Email
Full Transcript:
Announcer: Welcome to the Financial Planning for Canadian Business Owners Podcast. You will hear about industry insights with award winning financial planner and entrepreneur, Jason Pereira. Through the interviews with different experts with their stories and advice, you will learn how you can navigate the challenges of being an entrepreneur, plan for success and make the most of your business and life. And now your host, Jason Pereira.
Jason Pereira: Hell. Welcome to Financial Planning for Canadian Business Owners. Today on the show I have Heather Hansen, lawyer and partner at Martha McCarthy & Co. Heather's a known and respected lawyer in the field of family law, and I brought her on the show to specifically talk about family law and its impact on business owners, specifically around times of marriage and separation, and to debunk a number of myths around what happens in both instances. And with that, here's my interview with Heather.
Jason Pereira: Good morning, Heather.
Heather Hansen: Good morning.
Jason Pereira: Thank you for taking the time today.
Heather Hansen: My pleasure. Thanks for having me.
Jason Pereira: My please. Heather Hansen of Martha McCarthy & Co., tell us a little bit about yourself and what it is you do.
Heather Hansen: I am a family lawyer. I practice in Ontario. I am a certified specialist in family law and what that means is that it occupies the totality of my practice. I've been practicing for just over 12 years now and one of the areas that I've developed a specialty in is the intersection of family law and business and how particularly business owners are impacted during a separate process.
Jason Pereira: Yeah. At first when people see family law they may wonder what the connection is, but yeah. When a separation happens, oh my goodness, does the business come into play heavily.
Heather Hansen: Yeah. It's one of those moving parts. Family law is an area that, just to start to frame our discussion, the system and the legislation was set up in a way that is intended and, quite rightly, accommodates the vast majority of Canadian citizens. So, set up to create quite a formulaic outcome for people who are, for example, T-4 employees of a large corporation, who have very straightforward income and who have generally very straightforward, an RRSP or a pension, or a single home.
Heather Hansen: The challenge, and I'm sure we'll get into it in more detail, but the challenge in a broad stroke way for business owners is that the system doesn't necessarily correspond with how they operate their businesses and some of the challenges with dealing with value and other considerations if they're confronted with a separation.
Heather Hansen: And so there's a bit of a ... Unfortunately for many business owners, there's this immediate disconnect between how they've operated and run their business and how they now have to account for that to their former spouse.
Jason Pereira: Like so many things in law you can't think through every possible permutation, but this is a pretty gaping one. One of the things that I often tell business owners, because they have a hard time wrapping their heads around it sometimes, because they're used to contract law and everything else, because that's part of the normal course of events in being a business owner. Is they often start looking at their situation with their spouse with the same lens.
Jason Pereira: I tell them off the bat they need to stop immediately because what a lot of them don't realize is that ... What most people don't realize is that, for lack of a better term, family law is like the trump card that basically trounces all other law out there. So, whatever you may think you have in terms of contract law, if it's not in line with what the Family Law Act says, you may as well just tear it up because the Family Law Act is going to take precedence over that. Would you say that's generally correct?
Heather Hansen: Well, I think that there is a tension in family law between ... And it has come out over the years and developed in a case law around party's ability to freely contract and ability to freely contract in the right circumstances is generally upheld. This concept that you're talking about, this idea that the family law system is inherently one that is preoccupied with protecting vulnerable parties and [inaudible 00:04:13] recipient spouses have a fair shake at the table.
Heather Hansen: How that translates often on a practical level is the things we would normally want to accomplish in traditional contract law, they're not available because, again, broadly speaking, family law does place this larger A's over any contract and evaluates it through the lens of fairness. That's very challenging because in the commercial context, most people enter into negotiations with parties who are like- minded, with comparable levels of sophistication, and they're entitled to contract as they wish, provided that they're dealing in good faith. And so that's a different paradigm in family law, for sure.
Jason Pereira: Yeah. I'd like to say that caveat emptor is not a thing here, right, so it's not buy beware.
Heather Hansen: That's right, actually. It's specifically rejected. It's a specific concept that the courts have said that notwithstanding, even if a contract was entered into freely with proper legal advice and with the benefit of what's called full financial disclosure, and we'll talk about that a little bit later, even under those circumstances there are some very limited circumstances where a contract can be set aside in its totality because it is what's called, not in substantive compliance with the Divorce Act.
Heather Hansen: Now, those are few and far between and I don't want to discourage people because part of my pitch on this podcast is going to be that people should consult often and early with family lawyers, particularly within their corporate life. There are things that we can do and there are strategies and there's approaches that we can do, but it is limited.
Jason Pereira: Yeah. There's two big scenarios, or big life events, hopefully only one life event happens to most people, but there's two bit life events that we want to tackle. One is what happens when business owners get divorced, which is hopefully the one we all avoid. Let's start there. How does a divorce for a business owner differ from, say, just a regular conventional employee?
Heather Hansen: In a lot of ways. I'm going to just start at the beginning of family law framework because it's critically important to understand and it's often one of the first things that a shareholder worries about when they're sitting in my office.
Heather Hansen: Just in terms of understand the framework of family law in Ontario, we have what's called a title-based system. So, in other jurisdictions, or historically in Ontario even, this concept of a community of property would exist. In Ontario assets are based on title, so if you own the asset it is your asset. You don't have a legal obligation to give your spouse a portion of the physical or actual asset.
Heather Hansen: What arises based on your respective net worths is an obligation under the legislation to share the growth in value that accumulates during marriage. That's subject to some exclusions and deductions that it's too detailed for this discussion. But the idea is that if you're a shareholder in a corporation, for example, your ownership interest in that corporation, you do not share and you will not be placed in a position where you are required to transfer a portion of your shareholder interest to the spouse. You may have to pay something on account of the value of that interest, but you don't have to give that interest.
Heather Hansen: That idea, that idea that title governs, is important for a lot of shareholders because it governs not just their relationship with their spouse, but many people have other shareholders within their entity and they're worried about the impact on other shareholders, and they're worried about the ability to continue to maintain their ongoing operations.
Heather Hansen: The reason I start with title, it's always good to begin at the beginning, is because many business owners, during the lifespan of their business, will take steps that impair their ability to control free title on separation. Let me just give you a few examples.
Heather Hansen: It's very common for a tax or corporate planning strategies to make your spouse a shareholder within a corporation, okay? What you're doing when you do that is you are giving your spouse an ownership interest and that ownership interest is a corporate relationship that is separate from your family law obligations. You don't get to take it back on separation, you have given it.
Heather Hansen: Another example is parties, depending on the lifecycle of their business, will also often receive tax or estate planning advice to give it back to what's called an estate freeze. In doing so, they may issue a new class of shares to a new group of shareholders and that may impact your ability to, again, value the business on block or your ability to deal with the asset on separation.
Heather Hansen: Another one that I-
Jason Pereira: That's an estate freeze situation whereby, say, the trust owns the shares and the original share owner's not a beneficiary. Estate freezes can be pulled off where there's third party trustees and the estate freeze is done, and that person is a beneficiary. But in cases where just my spouse and kids are the beneficiary, hey, I can't circumvent the fact that they have a right to that.
Heather Hansen: And you've given it away, right?
Jason Pereira: Yeah.
Heather Hansen: You've given away the value that goes into the trust, and so that has an impact in family law. I have lots of clients who come into my office and they say, "Oh, well. We did an estate freeze and I gifted all the common shares to my three kids and they're sitting in there and that's where all the value is. My preference shares have a nominal redemption value," and then we're getting into a dispute sometimes with adult children about value, division, a whole bunch of complicated things.
Heather Hansen: Generally speaking, my advice to people when they come and they have a consultation when they're thinking about estate or tax planning is your estate and tax planning should come first and it should take the priority. Because the family law, if and when there's very little, again, coming back to how we opened this discussion, there's not much we can do other than what's called a marriage contract in some circumstances. And-
Jason Pereira: Which we'll get to, but there are myths about that too.
Heather Hansen: But the reason I say it is mostly just to ... I think your question how is it different, and these are examples of how it is different, and it can be very different.
Heather Hansen: The other way that it's different for business owners is on what's called the disclosure and the valuation piece. Once we figured out this mess than be title, who owns what, then we have to deal with valuation. Although there is a definition of property under the Family Law Act, there is no definition of value, and for good reason.
Heather Hansen: So, value does not equal fair market value, and value does not unnecessarily equal some prior indicator of value, for example, a prior sale or a prior transaction. Any business owner will tell you that the only true indicator of value is a transaction at the time in question, so any person who is obliged under the Family Law Act to crystallize value on what is called the date of separation, and impress a value at that time.
Heather Hansen: They are confronted with the behemoth that is valuing an interest in a privately-held corporation. That is a very challenging exercise in the best of circumstances, let alone when you have a spouse who has an interest value being as high as possible. And so I can answer questions about disclosure, but it's a major challenge, particularly if you're in a minority position within a corporation.
Jason Pereira: Yeah, that's an interesting one. I want to touch on a couple of things you mentioned there. One, going back to the estate planning and tax planning. It's one of those things where you can only based a decision based on the facts at the time and, assuming the marriage is on solid footing and everything looks good right now, then, "Hey, you know what? The tax planning and all that looks goods," but a marriage can deteriorate after 40 years. You don't know for sure how it's going to pan out, but you do what's best ...
Jason Pereira: In financial planning you have to do what's best for you at the time, without trying to pin yourself down too much. The valuation piece is yes, a tricky one. In fact, for those of you who want to hear more about that, go back to Episode 20 where I spoke to Melanie Russell about this very topic.
Jason Pereira: And the other thing too is when you look at statistics on business owner bankruptcy, divorce is one of the biggest issues surrounding that because a business is not a liquid asset. Unless you're just flush with cash in this business, I've literally had countless divorce cases where business gets valued, the operating spouse basically look at the valuation and says, "If she wants to buy it or he wants to buy it for that price, they can go ahead because there's no way it's worth that."
Jason Pereira: But now you're at an impasse because, at the end of the day, that person's entitled to maybe up to 50% of it, depending on the fact pattern of the marriage. That obligation is typically not held by ... Typically, the other spouse wants their money and a lot of times it's just some sort of loan or payout arrangement that comes up between them and, if the business runs into trouble, boom. Bankruptcy happens.
Heather Hansen: Yeah. I know having a divorce lawyer on your podcast is a lot of doom and gloom, but there's some strategies on this-
Jason Pereira: Reality. I call it reality. [crosstalk 00:13:07] a certain percentage of listeners are going to have that happen.
Heather Hansen: Yeah, so let's talk about some of the constructive things that come out of those problems. Again, just one problem before we start talking about solutions.
Jason Pereira: Enough.
Heather Hansen: Is what divorce lawyers call the golden goose problem, which is just building on this concept that you're talking about that a value is impressed on the business, but you can't sleep in your shares. You can't cash them out. There may not be an interested buyer. So, this asset that has value for most business owners is also the asset that generates income purposes.
Heather Hansen: And so the consequence of demanding an equalization payment, meaning a payment on account of the value of the business, is that you might kill the golden goose. You might find yourself in a situation that the [inaudible 00:13:59] you receive forces the sale of the business and then you have no support because often people who are entrepreneurs enter into business because of the income generating abilities as much as the value of the underlying asset, right?
Heather Hansen: So that's a big problem, so let me talk about some of the things that we do, as family lawyers, when parties are like-minded or cooperative. If they're not-
Jason Pereira: You can talk about what happens when they're not, afterwards.
Heather Hansen: Yeah, that's what I was going to say. If they're not, they can come and talk to me and I'll litigate their case for them. But in the vast majority of our cases, even though I have a pretty active litigation practice in this area, because sometimes disputes just require a judge. Separate from that, the vast majority of these cases are negotiated and there's a negotiated outcome.
Heather Hansen: Let's talk about some of the tools that we have when we have this golden goose problem or we have a valuation problem, essentially an inability to create a liquidity events to make the equalization payment.
Heather Hansen: Some recipient spouses will agree to a deferred equalization payment subject to proper [inaudible 00:14:54]. For example, we give them some security in the form of sometimes a share pledge, sometimes some sort of escrow agreement, and they agree to defer their capital payment or to take the capital over time.
Heather Hansen: Another option that some recipient spouses will agree to is family law, again, it's a very point in time analysis when it comes to division of property, so we equalize assets on the date of separation. For some spouses who are recipients, through a negotiated outcome they may decide that actually it's better to stay in business with their spouse.
Heather Hansen: And so, they may agree to not only defer an equalization payment, they may agree to waive an equalization payment or an ownership or a non-control position in the corporation, so a ride-along. So they get the benefit [inaudible 00:15:46] and then they also the benefit of the income stream.
Heather Hansen: Sometimes they do combination deals where a business that has value [inaudible 00:15:54] was the income generating validity of that business, that's where the real value is. And so sometimes spouses will agree to, again, defer to discount their equalization payment in consideration of a much higher support payment in the short-term. So, there's all sorts of tools that we can use. The problem is, is that all of those tools require a willing and active recipient spouse to negotiate.
Heather Hansen: And absent that willingness, what a court does is a court fixes value at a specific date and orders judgements. That doesn't help a business owner. It can be very problematic.
Jason Pereira: Yeah. As for the entire notion of having the court assign one, that's never a good position to be in, the last thing you want. You lose all control. It's now completely out of your hands and a third party decides it and that's the end of it. I think we addressed that pretty well. It comes down to the valuation of the business, the income generation of the business.
Jason Pereira: Now, let's get to a stickier subject surrounding this. What happens when some of that income from the business may not be fully reported, which is not uncommon in various cash business industries? I've often had spouses come to me and say, "Well, I know the business is worth something, but they're in renovations, construction," just to pick on those areas. Is it all truly reflected?
Heather Hansen: Okay, so again, just in terms of the baskets that we deal with in family law, there's what's called division of property, which is where we turn our attention to the value of the business and your obligation to equalize. The other piece, which we've touched on a little bit, is this idea of support. Support is child support and spousal support and those [inaudible 00:17:29] support are based on income.
Heather Hansen: You're quite right. Not by just what is report on your income tax return or what's reported necessarily in the net income of the corporation. There are many circumstances where unreported income or, importantly, expenses that a business owner runs through the business, that's a lot more common.
Heather Hansen: We see cash business, we see unreported income and it does up. More often than not a business owner in that position where they have cash income is going to be mutually invested in doing a deal, early and-
Jason Pereira: Yeah, [crosstalk 00:18:03]-
Heather Hansen: ... acknowledging that.
Jason Pereira: As possible. Let's get this out of the way.
Heather Hansen: As fast as possible, right. I see that, we see that a lot. What's really the challenge is somebody who is a small business owner who runs significant expenses through their business, I'll give [inaudible 00:18:16]. And insurance, somebody who's in the insurance industry.
Heather Hansen: I had a case a few years ago and they had a condo in Miami that they completely expensed through the business and it was an extraordinarily expensive operating expense for the business and I was on for the wife in that case. But the husband, his position was, "Here's my client list. Here's my referral base. I use it for hosting," and there was this whole debate about whether had a personal or a business element to it for support purposes.
Heather Hansen: Because any expense that's run through the business will be added back and grossed up for purposes, so you can put yourself in a position where your income for support purposes might even be higher than the gross income of the corporation, depending on if it's a professional services firm, for example.
Jason Pereira: Yeah, so before anyone gets these smart ideas about buying condos in Miami because of listening to this, let's just be clear. Personal use gets added back to income, so when come to me and say, "Should I buy this car," or whatever it is in the business, I'm like, "Look, it's kind of irrelevant. If the money's there, great. That's where you can buy it, but at the end of the day you're still going to pay taxes on personal use."
Heather Hansen: Yeah, 100%.
Jason Pereira: Yeah.
Heather Hansen: That's the issue. Yeah.
Jason Pereira: Yeah, so I mean a couple of things that's just a high level. Let's just go back and let's sum a couple of things up. One thing we didn't mention is, again, you mentioned exemptions briefly.
Jason Pereira: So, someone gets divorced, there's a division of assets and there is income support and child support, three different buckets. There is some flexibility in negotiation between the first two, but one of the thing people don't realize when they come into these things is it's the marital exemption. Can you explain if I come into a marriage, I am worth, we'll call it $2 million and the other person's worth $1 million? Down the road we get separated and then totals for, what does that look like from a division of assets level?
Heather Hansen: Yup, and this is also another really example of where having a family law advisor when you're thinking about getting married can be very helpful, when you're a business owner.
Heather Hansen: So, the calculation of net worth under the Family Law Act, which is this number that we reach and then if your number is bigger than your spouse's number, you owe a payment, a cash payment to equalize, okay? That calculation is subject to two adjustments.
Heather Hansen: The first adjustment is what's called the date of marriage deduction. If you think about it intuitively, the legislation says, "That parties only share in the growth of their net worth acquired during the marriage," so if have an asset on the date of marriage and you can establish the value of that asset, that is forever a deduction from the calculation of your net worth.
Heather Hansen: If, on the date of separation, you're worth $10 but you brought $2 into the marriage, your obligation is to equalize only the $8 that accumulated during the marriage, for example. And for business owners, again, when we come back this valuation proposition, it is sometimes in their interest at the time of marriage to crystallize value, or to have their spouse agree to the value on the date of marriage. So at the bare minimum they have protected and preserved that date of marriage deduction for all time.
Heather Hansen: That can be very useful in that sometimes, just to be super-practical about it, it's not worth the effort. And again, to your point, you do what's right for you at the time and you deal with the problems down the road, but it's something that I would want to have a conversation with, with a business owner in a perfect world, prior to a marriage. Especially if the business is a going concern with a significant value, so a professional services firm or something like that, but if you've got a going concern, industry-based business, I would want to have that discussion.
Jason Pereira: Well, it's smart. It eliminates the ambiguity 20 years down the road, "Okay, what was this really worth?" And a little planning tip, and one thing that I don't tell my clients I do when they're getting married it's like, "Oh, yeah. When's the wedding date? Oh, that's great," and then I set a task for my assistants to run a statement on that date and keep that in arrears. Just that way-
Heather Hansen: Net worth [crosstalk 00:22:07]-
Jason Pereira: Exactly, right? Because systems change, advisors migrate, companies, whatever it is. I don't know where I'm going to be in 20 years, but I'll probably still be in this business somewhere. But having that kind of temple right there just basically saying, "Hey, here's the sheet. This is what you were worth on that day," it's already saved the client once or twice.
Heather Hansen: In that regard, even if you don't, for example, get as far as your spouse agreeing to a value by way of a contract, I agree with you completely. Just actually doing a clear accounting of what your assets are and making sure that you've got, at bare minimum, the year-end financial statement, that you've got it available and it's part of your calculation if you've made any applications for lending, or anything in that year and you've given it to third parties, protect all those key data points. Just the fact that the exclusion [inaudible 00:22:56] because it-
Jason Pereira: Yeah, it's finished up. One up.
Heather Hansen: ... it's a very complicated area of law, the relationship between date of marriage deductions and exclusions. This comes also to when business owners should be having a conversation with a family lawyer, even as just part of their estate planning, not necessarily because a separation is imminent.
Heather Hansen: The other category of adjustments to the calculation of net worth is this idea that if you receive during the marriage a gift or inheritance, and so the definition of a gift if you receive something without consideration. An inheritance is obviously something bequeathed to you, or that you received through death when someone doesn't have a will.
Heather Hansen: But if you received those assets during the marriage and two qualifications-
Jason Pereira: There we go.
Heather Hansen: ... continues to exist at the date of separation and/or it is not the matrimonial home at the date of separation-
Jason Pereira: Which we'll get to there.
Heather Hansen: Which we'll get to. Then you're entitled to exclude the value of that. One of the key distinctions between a date of marriage deduction and an exclusion is that the value of the date of marriage deduction exists for all time. You do not need to retain the asset at date of separation. The challenge with the date of marriage deduction, which is intuitive, but it is a challenge, is that unless you have a contract you're obliged to share in the growth, okay?
Heather Hansen: An exclusion is when you ... Where exclusions crop up for people is mostly in estate planning where a business owner, like a matriarch or a patriarch starts gifting to children and then those children start getting married, okay?
Jason Pereira: Yeah.
Heather Hansen: And [inaudible 00:24:32] having larger claims within the family constellation, intergenerational challenges, which can be also another good time for a discussion about the necessity of a marriage contract, for the utility.
Jason Pereira: We're going to come into marriage contracts very soon, but we've sliding into from many angles. Yeah, it's interesting. This happens all the time. The inheritance gets paid out and the first thing people say is, "Look. I want to pay off the family home, the mortgage," and I say, "Well, let's explain how this works. Not making a comment on your marriage, but should I ever dissolve, here is the reality of it."
Jason Pereira: So, first off, I always coach people that if you're going to start using this to basically live a more elaborate lifestyle, you're opening up the door to that other person potentially having claim. And if you're going to use, you're going to spend it, then it's gone.
Jason Pereira: But especially in a family home. Let's talk about what happens. Why is the family home different, because we've kind of worked around it a couple of times. Why is it different in the face of family law?
Heather Hansen: Under the Family Law Act there's a separate section of the legislation that deals solely with the matrimonial home. Just from, again, a high level policy perspective, coming back to the system is set up to protect 90-95% of the population, but most people, their primary residence and matrimonial home because, by the way, you can have more than one matrimonial home. But your matrimonial home/primary residence for the vast majority of Canadians is a single home and it's often their most valuable asset.
Heather Hansen: And so the legislation has created a bunch of exceptions to treat that asset as a shared asset, regardless of how people organized around it. It's kind of a hot topic in family law. There's lots of family lawyers who think that that's wrong and unfair because of some of these things like inheritance is going in, and I'll go back to that.
Heather Hansen: Then there's a lot of people, particularly people concerned with the feminization of poverty and making sure that people have a fair shake. On [inaudible 00:26:27] you actually think that it's a good policy. But basically what it is, is that if you ... The definition of matrimonial home is a home that you ordinarily occupy during your marriage at the date of separation.
Heather Hansen: Again, you can have more than one, so your cottage in Muskoka that you go to all summer and your house in Oakville. Those two things can be matrimonial homes at the same time. But if it meets the definition of matrimonial home under the legislation, two things happen. First, you lose your ability to deduct the assets. So if it's a home that you brought into the marriage, you lose your date of marriage deduction. That is a critical miscommunication to the Canadian public that people do not understand.
Heather Hansen: They're told, or they understand if they do a basic Google search, that you only share in the growth of the value of net worth, except if it's your matrimonial home.
Jason Pereira: Yes, so big asterisks there, right?
Heather Hansen: Right, and it's a [crosstalk 00:27:21]-
Jason Pereira: I own a house, fully paid for, for whatever reason spouse moves in. Guess what? 50% up for grabs now.
Heather Hansen: Right. [inaudible 00:27:28] that home and you're out of luck. That, by and large just in terms of practice, and I know we're edging up to the [inaudible 00:27:35]-
Jason Pereira: It's the next thing. It's the next thing.
Heather Hansen: Yes, but by and large I would say 90% of marriage contracts that I do are simple single issue contracts to protect money that is going into mat homes. We're either protecting it because it was an asset they brought into the marriage or, and this is the sort of second qualification, and you mentioned it briefly, that if you receive a gift or inheritance and you put that into the matrimonial home, even though the law in other circumstances does provide for what's called tracing.
Heather Hansen: If you receive an inheritance and then you put in a bank account and then you buy some stocks, if you can prove a straight line ... Although the law will recognize this idea that if you receive a gift or inheritance, if that asset changes color or character during the relationship, if you can still prove the existence of the exclusion. For example, you receive an inheritance in the form of cash. You put that cash into an account. You then purchase stocks and you can prove, and the proving of that is a whole other podcast, but you can-
Jason Pereira: Or a simple thing. Just keep it as one separate account at all times and separate bank account if you can, and that makes it easy.
Heather Hansen: That is the number one tip, for sure, because of this exact problem. That concept, so either, as you've said, you've got a nice tidy bow wrapped around your exclusion because you've kept it in a single account. Or you're capable of tracing it, the exclusion still survives provided the asset exists on the date of separate.
Heather Hansen: The critical exception to that is if the thing that you have put your money into is the matrimonial home or the thing that you received by way of gift and inheritance is the matrimonial home. So the biggest and most problematic example of that is a child receives a cottage. There's a child, a parent dies, a child receives a cottage. That cottage was a gift received or an inheritance received, but then it becomes a matrimonial home.
Heather Hansen: And so that, again, it's not necessarily a business owner issue, but it's an issue that crops up in the context of these types of exclusions and how sometimes when we're contracting around these issues, those are things that we commonly turn our minds to.
Jason Pereira: Makes for success. Let's talk about, we've been kicking around for a while, which is the concept of a marriage contract, or more affectionately known by the general population as the da, da, da, da, prenup.
Heather Hansen: The prenup.
Jason Pereira: The prenup. And I can't tell you ... I'm sure you're familiar with this, but there is no contract I've ever come across that has more misconceptions about what it can and can't do than the quote-unquote, "prenup". And let's just clear up one thing quickly.
Jason Pereira: Prenup, meaning prenuptial, which is just a reference to timing, doesn't have to be before, right?
Heather Hansen: That is correct. That is correct.
Jason Pereira: So, we can have a postnup. The bottom line is that's why the term marriage contract is so much nicer, it doesn't have the negative connotations and it also doesn't have a timing thing affixed to it. But you can do this after you're married too.
Heather Hansen: You can also, just to add one more wrinkle or benefit, you can also enter into a domestic contract that is not in contemplation or during a marriage, and so for parties who [inaudible 00:30:50] have it. There's another whole separate basket of legal risk and obligation that arrives through cohabitation that you can also, in some circumstances, contract it out.
Jason Pereira: Yeah. The one thing we didn't cover, and we should probably talk about this quickly, is that when is the law consider you married for common-law purposes? So that is, for tax purposes, 12 months and everybody always thinks about that. For income support, under the Ontario Family Law Act, three years. However, if you're having kids and doing other things that basically look like you're fully married, that number may just go out the window, right?
Heather Hansen: Yeah, so just in terms of broad stroke educations. In Ontario, people who are legally married and unmarried people, who cohabit for a continuous period of three years or have children. So they cohabit for an uninterrupted three years or they have children, those people treated the same with respect to custody and access issues, spousal support and child support.
Heather Hansen: The only area where there is a legal distinction between married and unmarried people is division of property. The law has said is that you, in order to have access to part one of the Family Law Act and equalization of that family property you must be married.
Heather Hansen: People have tried to attack that proposition in a bunch of different ways over the years, and the courts have quite strongly upheld that principle, that only married people get that calculation of net family property.
Heather Hansen: But marriage contract discussion. You can still have a cohab to deal with some of the issues that arise when people are cohabiting.
Jason Pereira: Excellent. Basically, let's talk about the process of what is required when putting together one of these contracts. What has to be brought to the table? What is different from normal ... There's one difference that I'm spoon-feeding you on this one, that absolutely has to be followed that is different from normal contract?
Heather Hansen: In a family law contract there's what's called civility and validity. So, a family law contract is virtually the definition of a domestic contract. It needs to meet all of the essential validity requirements. It needs to be signed by both parties. It needs to be witnessed and it needs to be dated. All that doesn't matter if it's not an enforceable contract.
Heather Hansen: What we're really talking about is if you are in a dispute with your spouse at the time of separation and you want to rely on the terms of the contract, what are the things that the contract needs to have? There's three key ones, but the most important one, over and time and time again, is this concept of independent legal advice.
Jason Pereira: That's the one.
Heather Hansen: Let's just talk about the three magic keys to an enforceable contract, and people often complete those things. So, you can have a valid contract that's [crosstalk 00:33:36] the formal requirements, but that's garbage if it doesn't have these three other things, okay?
Jason Pereira: Exactly.
Heather Hansen: The three other things are independent legal advice, meaning that both parties, but particularly the party who's giving up rights, has had the benefit of full dialogue with a family lawyer about the legal issues, rights and obligations that exist under the contract. The second one, which is also ... It is different than many commercial contracts, is you have an obligation to provide what's called full financial disclosure.
Heather Hansen: And if you think about it just in concept about what these contracts are doing, these contracts are fundamentally a contract where one party who's a power holder is asking somebody else to give something up in the future. And so in the most basic, if you're talking about this idea of family law being preoccupied with fairness, a spouse who's going to give something up needs to know what it is they're giving up, just in the most basic terms.
Heather Hansen: You got to understand what it is you're giving up before you can give it up. And so, except for the most extraordinary circumstances, where the value of the asset is irrelevant. If someone's worth $25 million or $35 million and they're asking for an exclusion for all time and they're [inaudible 00:34:48] for all time, arguably whether it's $25 or $35 million doesn't make a material difference.
Heather Hansen: But if you're asking, for example, to exclude your business interest for all time it's pretty important that the spouse understands what the value is of the thing that they're giving up, or what the potential growth would be. So, this concept of financial disclosure is very important.
Heather Hansen: Then the last one, particularly in the context of marriage contracts where a marriage is imminent, is the absence of duress or the absence of pressure, okay?
Jason Pereira: Mm-hmm (affirmative).
Heather Hansen: That's a very complicated area of law and, just to give an example, when you mentioned that these contracts, there is no other area of law where contracts are more frequently misunderstood or misinterpreted. Of the last five Superior Court trials that I've conducted, three of them, and one that was supposed to start right before the pandemic hit, three of them and then the one that I have on the books to start, which is a six-week trial, a six-week trial dealing with valuation of business issues and a marriage contract, they are attacking the validity of contracts, marriage contracts.
Heather Hansen: Marriage contracts are commonly attacked on the basis of absence of financial disclosure, the presence of duress, or the spouse who was giving up the interest did so without the benefit of legal advice.
Jason Pereira: Which is a big one because, oftentimes, people try to cheap out on this by saying, "Well, you know. We only need one lawyer." I'm like, "Don't even start. That paperwork will just be shredded the second it's challenged."
Heather Hansen: It's garbage.
Jason Pereira: It's garbage.
Heather Hansen: It's garbage. And the thing is, is that people are often frustrated by the process that I force them to go through when they're entering into these contracts. They'll be like, "Why do I have to meet you three times? Why does she need to go to the lawyer three times? Why is this contract costing me-"
Jason Pereira: You want it to work.
Heather Hansen: You want it to work and, also, think about the value of the assets we're trying to protect. There is a proportionality analysis about if we're trying to protect something that's very significant, it's in your interest to invest the time and money to make sure that you're able to do that.
Jason Pereira: As I always tell everybody when they say, "I want X to be quick and cheap," I'm like, "You know the words quick and cheap and family law never go together, right? Just strike those first two words because put the opposite up, because that is the difference, okay?" But it's valuable for reasons.
Jason Pereira: One key area I want to talk about is misconceptions about what these thing will do. Yeah, there are some cases with exceedingly wealthy people where unequal distribution of assets is not going to impair the person's ability to sustain themselves. But for the rest of us humble beings the reality is, is that I've oftentimes sat down with people and they said, "Oh, yeah. I got a marriage contract. I got protection on my real estate properties or my business, both the base value and forever." I'm just like, "That's an interesting concept. Can you tell me how that works?" Before it doesn't.
Heather Hansen: Yeah, so my marriage contract mantra, if you will, is to keep them as simple as possible and to do as little as possible in the contract for many of the reasons that you're just talking about. People will come to me with their shopping list and say, "These are all the things I want this contract to do," and the opportunities you give within a contract to create challenges, the harder it's going to be at the end of the line to uphold it.
Heather Hansen: Really, I think what your question is more about is what are the common forms of these types of contracts? So, most-
Jason Pereira: I think that what I'm getting at is the ... We went into this and not it's forever going to be what's mine is mine, what's theirs is theirs. The growth is each person's, and that's the end of it. There's going to be no splitting of anything.
Heather Hansen: Yeah, so those contracts, that type of contract, which is what's called a full separate and apart contract, meaning title will govern for all time and there will be no sharing. It's a full contracting out of the family law regime. Those contracts are appropriate for the following groups of people and only these people.
Heather Hansen: Two independently wealthy people coming into a marriage with complete independent wealth who wish to maintain that wealth, so movie stars, rock stars, very rich people.
Jason Pereira: No question of being able to live that lifestyle should they separate.
Heather Hansen: Yeah, like that whole thing. The second class of people who I commonly see entering into separate and apart contracts are people who are in their second or third marriage, where estate planning or other purposes, notwithstanding the fact that there may be a disparity between them, they're at an age and stage where they're more concerned with protecting their existing wealth for future generations than sharing it with their spouse.
Jason Pereira: So, we're not really talking about someone who got divorced at 25 and is getting remarried at 30? That's not the [crosstalk 00:39:09]-
Heather Hansen: No.
Jason Pereira: ... we're talking about later stage in life, 60, 70, whatever it might be, right?
Heather Hansen: Yeah. I'm talking about a widow in his 60s marrying a woman who's been married once before, who both are tapping into their retirement assets and adult children who they're helping. Like that, right?
Jason Pereira: Yeah. And in that case, I mean, they've both reached the finish line financially. They're able to retire, so similar principle. It's that we can support ourselves individually, but we can also support ourselves together. In which case there's not an imbalance there, so those are the only two scenarios. Now-
Heather Hansen: Those are generally. Now, the third scenario which is, again, this is a bit falls into the rock star and movie star category, is when a party, as a result of the vast size of their wealth, wishes to have a full separate and apart as to property contract, but what they're prepared to do in exchange for that is to essentially give consideration for that.
Heather Hansen: A, you're never going to get anything from me. We're never going to share the value of our business. We're never going to share the growth. I'm never going to do any of that, but if we separate after 10 years I'll give you $10 million bucks, whatever.
Jason Pereira: You'll be well taken care of, but you ain't touching this.
Heather Hansen: That's right. And so when somebody has the luxury of essentially picking a number that will, for all time, be satisfactory, like some huge big number like that. Where we see that often is with intergenerational wealth. So when we see a family, a multi-generation business that very, very large and the complications and challenges that we've been discussion would be so monumental for the family, that just having sort of a clean break contract with very [inaudible 00:40:58], sometimes we see that.
Heather Hansen: But other than those three circumstances we don't usually do those types of contracts. It's another kind of contract that we do.
Jason Pereira: But that said, more often than not ... No, I don't say more often than not. On countless occasions I have seen that. I have seen that done for average business owners, average consumers, someone who's got one rental property and case in mine, I'm not going to name you, you know who you are. He gets married. He's in his late 20s, early 30s and he's like, "Yeah, no. I got two rental properties. I've got the principal. I got what I came in with and I've got it forever," and I'm just like, "That's just not going to work."
Heather Hansen: That's garbage. It does more harm than good. There is a class of excluded assets under the Family Law Act that deals with things like what we've touched on gifts and inheritances. One of the easiest, and when I say easy I mean the most straightforward, way to create a contract that protects some things, is to expand the definition of what is an excluded asset.
Heather Hansen: For example, you can say that the parties wish to exclude the matrimonial home. Or, the parties wish to exclude my business interest. Or, sometimes the interest in the trust or whatever it is. And so you create a class of assets that is excluded. Now, that creates a whole other set of problems because then what some people will do is they use their class of assets to shelter all of their assets. They'll say, "Well, Corporation ABC will an excluded asset," but then they hold all of their house in [crosstalk 00:42:34]-
Jason Pereira: Yeah, everything's there. Yeah.
Heather Hansen: And so that undermines that objective as well, so if what you're doing is trying to create a class of excluded assets, it has to actually be for the specific purpose of protecting that specific asset, not as a vehicle to create further exclusions. That's the one we see most commonly, to be honest. We see people wanting to-
Jason Pereira: [crosstalk 00:42:52] shell game?
Heather Hansen: Yeah, yeah. Exactly. We see people wanting to just ... The most common example of where a marriage contract is a value to a business owner is when, for example, they are a one-third shareholder in a going concern business with a shareholder's agreement with two other shareholders and the business is new and difficult to value, and is also a primary income generating tool.
Heather Hansen: In those circumstances, having your ownership interest in that business falling within the class of excluded assets will allow you to not have to share that value on separation. The elephant in the room, with respect to these types of exclusions, is that, and many of your listeners will be familiar with this concept, there is no contract without what is called consideration. So, you don't get it for nothing and the higher the degree of what you're asking to exclude, the more the lawyer for the recipient spouse will be asking for you to embed some consideration into the contract.
Heather Hansen: So, I say to you, "Oh, yes. Let's create a class of excluded assets. You better be prepared to give your future spouse a house, an investment portfolio, or something in consideration to represent some fair dealing as between the two of you."
Heather Hansen: That is often where these contracts fall down because someone will say to me, "Well, I want to create a class of excluded assets," and then it gets sent over to the lawyer on the other side and they say, "Why would she ever do this? What is the reason why she would enter into this contract? And you need to be able to provide something in consideration." That can be very challenging, especially for young couples.
Jason Pereira: It's interesting too because it's almost as if someone comes into it ... I've seen this happen before. Someone comes into it from the standpoint of, "Well, I'm just trying to protect what's mine," and then they feel like they're suddenly being asked to negotiate something.
Jason Pereira: I think the conversation usually goes to, "I don't think you realize that when you started this, you started a negotiation," right? "You may see it as protection, but no. What you really did was a negotiation, so that's where we are."
Jason Pereira: Before we wrap up, any last tips for what to consider when putting together a spousal agreement?
Heather Hansen: Yes, two short tips. There contracts take an extraordinarily long time to negotiate, okay?
Jason Pereira: Mm-hmm (affirmative).
Heather Hansen: Way back, just because we're wrapping up I won't spend an hour talking to you about all the complex reasons they take so long. All you just need to [inaudible 00:45:27] is they are the hardest and longest ones. And so you need to start early if you're going to even explore this issue you have to start ... Don't come to me two months before your wedding date and say that you want to explore a contract.
Heather Hansen: By the way, if you do that, we do have some tools to assist. We have contracts call standstill agreements that allow parties to go ahead and get married, and then enter into the negotiation at a later date. But those have their own warts on them, so start early is my number one tip.
Heather Hansen: Then, also, be prepared to invest time and money in the process. Most importantly, be prepared to have the process fail because the negotiation of a marriage contract, coming back full circle to what you said, which I think is really great advice, Jason, but you have to make financial decisions at the time based on what's best for you. We can not always control the future events.
Heather Hansen: Just in terms of being human beings, not divorce lawyers, nothing upsets me more than people ... I've seen relationships end because they couldn't negotiate a marriage contract. There's problems that we can solve in the event of a separation. And yes, there are lots of cases where people are unhappy at the end of their separation because of the financial outcome. But by and large, that's not the case. By and large we work it out and we get people to where they need to be, even if they don't have a marriage contract.
Heather Hansen: Many people are very preoccupied with it being a requirement. It's not a requirement. I would frame them as nice to have, not have to have, for the vast, vast, vast majority of Canadians. For many Canadians, not only is it not nice to have, it's unnecessary or problematic.
Heather Hansen: So my advice is go into the process with an open mind, start early, be prepared to invest the time and energy into it and be prepared and willing to abandon the project if it seems to be more of a problem than it's worth.
Jason Pereira: Heather, thank you very much for your time. Can you let us know where people can find you?
Heather Hansen: Yes. My website is McCarthyCo.ca. My email address is Heather@McCarthyCo.ca, M-C-C-A-R-T-H-Y-C-0 dot C-A. And you can Google me. I have a web presence, a Twitter account and you can follow me on Twitter. I occasionally updates about things that are going on in family law, so maybe I'll see you there.
Jason Pereira: Yeah, I'm like many of us in personal finance, you don't get involved in contentious debates [crosstalk 00:47:52] do you?
Heather Hansen: No, I do not. I stay out-
Jason Pereira: You're a very prudent lawyer.
Heather Hansen: I'm a pretty vanilla Twitter participant, but I will occasionally post interesting legal bites or significant cases and stuff like that. I can keep people in the loop.
Jason Pereira: Fantastic. Thank you so much, very much appreciated.
Heather Hansen: My pleasure. Thanks so much for having me.
Jason Pereira: So, that was my interview with Heather Hansen. I hope you enjoyed that and I hope the one thing you took away yet again, is that proper advice is required in moments when you need them in life. One of those moments is around marriage. Should there be imbalances, as we discussed earlier, and if you're a business owner it's even more important.
Jason Pereira: As always, I am Jason Pereira and this has been Financial Planning for Canadian Business Owners. If you enjoyed this podcast, please leave a review on iTunes, Stitcher or whatever's in your podcast. It does help people find us and I truly do appreciate it. Until next time, take care.
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