Loophole Prevented: Selling a Business During a Divorce

In Marital Dissolution, Minnesota Appellate Decisions, Supreme Courtby Joseph PullLeave a Comment

Stacking together two major life events – a divorce and the sale of a multi-million-dollar business – can be a recipe for major headaches and complex interacting consequences.  In the recent Minnesota Gill case, a business sale during a divorce revealed a potential loophole through which an owner-executive tried to avoid sharing assets with a soon-to-be ex-spouse – but the state supreme court blocked the maneuver.

On October 24, 2018, the Minnesota Supreme Court issued a decision requiring an ex-husband to split the proceeds of an “earn-out” provision with his ex-wife, notwithstanding that the contract granting the earn-out was signed after the valuation date in the marital dissolution case. The earn-out was part of the purchase agreement for a valuable company.

The case presented a question of the boundary between two fundamental principles of Minnesota marital dissolution law:

  • All property acquired during the marriage is subject to division between the ex-spouses.[1]
  • Property acquired by a spouse after the valuation date in the dissolution is not subject to division between the ex-spouses.[2]

In Gill v. Gill, the spouses had acquired an indirect ownership interest in a company, Talenti, during the marriage. Stephen Gill, the husband, became the CEO of Talenti. Talenti was owned directly by a holding company, David Goliath Group LLC, and the Gills owned 80 percent of another holding company, Wyndmere LLC, which owned about 39 percent of David Goliath.

Income and property acquired after the valuation date is not subject to division.

Stephen petitioned to dissolve the Gills’ marriage. The valuation date was set as September 5, 2014.  On December 2, 2014, David Goliath and all its assets were sold to Unilever. The terms of the sale provided an immediate cash payment of $180 million from Unilever, but also required Unilever to pay the former owners two additional amounts in the future, “earn-out” payments which would be based on Talenti’s future sales after one year and after two years. The total of these earn-out payments could range from $0 to $170 million, depending on Talenti’s performance.

Stephen claimed the earn-out payments were non-marital property, since they would result from the performance of Talenti during the years following the valuation date in the dissolution. He argued these earn-out payments were essentially compensation for his future work as CEO.  Gretchen Gill argued on the contrary that the payments were marital property, since they resulted from the sale of the marital interest in Talenti.

The trial court sided with Stephen, but the court of appeals and the Minnesota Supreme Court both concluded that Gretchen was correct. After examining the language of the Talenti purchase agreement, the Supreme Court characterized the earn-out payments as part of the price paid for Talenti, not compensation for Stephen Gill’s future employment efforts. Critical to the Supreme Court’s decision was the consideration that the other former co-owners, not just Stephen Gill, would receive the benefit of the earn-out payments. Under the trial court’s approach, “perversely . . . Gretchen would be the only person with an interest in David Goliath who would not share in the earn-out payments.”[3]

Gill speaks to whether a payment right that straddles the line of the valuation date is marital property or not.

The Supreme Court’s opinion, from the vantage of a non-participant in the case, seems clearly correct. The earn-out was part of the package given in exchange for the ownership of Talenti. Therefore, the earn-out constituted property acquired in exchange for marital property, which is indisputably also marital property.[4] It is true that the future labors of Talenti’s CEO would affect the amount of the earn-out; that is inherent in the nature of an earn-out. But shareholders are supposed to benefit from the labors of a company’s CEO, so it is neither surprising nor remarkable that the compensation received by the shareholders for selling their interest in the company could depend upon the CEO’s performance.  The CEO is separately compensated according to his own employment agreement with the company – in Stephen Gill’s case, a salary of more than $362,000 per year. Stephen’s salary, to be earned after the valuation date, was non-marital property. But the earn-out was a contract right received in exchange for surrendering the marital property of the shares of Talenti, not a form of employment compensation.  As the Supreme Court pointed out, the other former owners of David Goliath, who were not married to Stephen, would benefit from the earn-out. Stephen had no claim to the share of the earn-out that belonged to the other former owners, so it would not make sense to characterize the earn-out as employment compensation to Stephen. Also, there was no necessary connection between Stephen’s job as CEO and his benefit from the earn-out.  If Stephen had not been CEO, he would still have been entitled to the earn-out. And if Stephen had been CEO but not one of the owners of Talenti, the earn-out would still have benefited the individuals who did own Talenti, even though the amount of the earn-out depended in part on Stephen’s performance as CEO.

Considering the issue from the perspective of potential manipulation in future cases strengthens the conclusion that the Supreme Court got it right. If the Gill earn-out had been treated as non-marital property, Gill would have created an incentive for divorcing CEOs to sell their companies on terms of sale which depressed the price paid up front in exchange for increasing the amount paid as an earn-out. The CEO spouse would have been given a tool to transfer money from the non-CEO spouse into his own pocket, through an unnecessary loophole in the law defining marital property. That outcome does not seem desirable or fair.

When a dissolution proceeding involves ownership of business interests, the stakes riding on the distinction between marital and non-marital property can rise dramatically. Going forward, the Gill decision may become an important authority for attorneys framing arguments about the marital or non-marital nature of assets that straddle the temporal line of the valuation date.

 

[1] See Nardini v. Nardini, 414 N.W.2d 184, 192 (Minn. 1987).

[2] In a dissolution, the trial court establishes a “valuation date,” see Minn. Stat. § 518.58 subd. 1,  which is the day as of which the couple’s property is valued and divided. The process of valuing and dividing the property may take months or years, but the valuation date eliminates the problem of a moving target.  In rough terms, no matter what happens after the valuation date or when the division is finalized, the property is divided as if the division actually happened on the valuation date. Therefore, events after the valuation date ordinarily do not affect the valuation and division. Property acquired by one spouse after the valuation date is presumptively treated as non-marital property of that spouse, not subject to division, and income earned after the valuation date is also not subject to division.

[3] Gill, no. A16-1421, sl. op. at 15.

[4] See Minn. Stat. § 518.58.

About the Author
Joseph Pull

Joseph Pull

Mr. Pull has represented clients concerning a wide variety of commercial and financial disputes, in state and federal courts inside and outside Minnesota. He provides counsel to owners of closely held businesses or partnerships, individuals involved in estate and trust disputes, businesses facing breach of contract or tort liability concerns, securities owners, and others. View Mr Pull's profile here.

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