Just as a CEO inflates the value of a company to attract a buyer by accelerating income and deferring expenses, it is an accepted fact among attorneys that an entrepreneur facing divorce will deflate the company's presettlement value by doing the exact opposite. One business consultant in a Chicago suburb, anticipating the breakup of his marriage, considered such tactics as entering into separate bank accounts, establishing new trusts, investing in side ventures, prepaying his taxes, and indulging himself in bigger but less obvious perks -- all of which are divorce shelters that are unlikely to be traced by a valuator. In the end, he decided it wasn't worth the energy to be so furtive. His strategy, rather, was to convince his wife that the business was more stagnant than prosperous.
"It was pretty simple," the consultant recalls. "First of all, you keep your mouth shut. You say nothing at home -- nothing positive, anyway. Even if you land a big contract, you say things are only OK at work, because you don't want that stuff thrown back in your face in court. Then, at the end of each quarter, you put everything in the worst light possible, and you tell your accountant you expect him to do the same. It was tiring, it was stressful, and I don't know that I'd do it again, but it worked."
Consider, as well, the California manufacturer who is still awaiting his property settlement. His company, which, by state law, won't be valued until his property-distribution case goes to court this spring, has had an abrupt falloff in business since he and his wife separated. Traditionally a better performer than its average competitor, the company's revenue this year is down by the same 28% the rest of the industry is reporting. Earnings are down as well. "It's partly the condition of the industry, and partly that I've had to reinvest -- spend a lot of money on executive-compensation packages for my top people, stock plans, and things like that. You have to address the long-term issues of the company periodically." But in describing his bad fortune, he does sound suspiciously gleeful.
Divorce-court judges will tolerate a little shading of the financial truth and a few fortuitous business setbacks. They'll even ignore a bit of tax fraud -- in fact, more than a few have glanced at bank-loan applications and other telltale documents produced by opposing lawyers, and hissed from the bench that they "don't want to hear about it," according to Los Angeles divorce lawyer Jan C. Gabrielson. "They don't want to know how much cash has been coming home," he says, "because it puts them in a difficult position." As one judge who participated in a seminar with Gabrielson put it to the audience, "Do I expose one or both parties to criminal tax fraud charges, or do I settle the divorce litigation on the basis of reported income?"
Judges are, however, disinclined to swallow blatant book-cooking, the kind obviously intended to boil dry the marital-property or alimony rights of the spouse. Sudden changes in business condition or status are nearly always scrutinized. The courts are also paying more attention to such defensive tactics as predivorce shifts of income or stock to sympathetic bystanders, including partners or family members.
One Miami-based clothier, for example, cut his salary from $120,000 a year to $70,000 when his wife filed for divorce. Interestingly enough, his brother, who was a partner in the business, got a $50,000 raise at about the same time. If there was a plan for the CEO to recoup that money, it never came out in court. The judge in this particular case opted not to explore the apparent income shift, because "he didn't want to spend the time," says opposing attorney Melvyn B. Frumkes of Frumkes & Greene. However, there have been similar but less successful ruses in other states. In some of them, the obliging partner was found to have paid the taxes on the additional income before returning his windfall under the table to the soon-to-be-divorced entrepreneur.
A more elegant twist to this sort of predivorce planning involved a Chicago entrepreneur and his partner-father, who entered into a stock-redemption agreement about 18 months before the entrepreneur filed for divorce. Almost immediately after the planning document was inked, the corporation began to redeem the father's stock at a grossly inflated price, draining the company of most of its profits. At the same time, the entrepreneur slashed his salary from $100,000 to $25,000. Under Illinois law, he might have used the business to shield his company and his income from a divorce decree. But he chose not to risk it, and settled with his wife out of court.
A New York state legislator, seeking to quell such abuses, has introduced a bill that would instruct judges to look at any property transferred within three years of the start of divorce proceedings to determine whether it had been done "in comtemplation of a marital action."
Some entrepreneurs don't stop with the mere juggling of dollars and cents. The founder of J&L Oil Co., an Illinois gas-and-oil distributor with stations in about 100 locations around the United States, simply dissolved the company's joint tenancy by signing his wife's name on the necessary documents. The trial court upheld Lester Wright's right to transfer company stock to a trust owned by him. But on appeal, Josie Wright prevailed -- the interest still belonged to her, and she was allowed to sell her stock.
