Benefits of a Prenuptial Agreement for Business Owners AND Their Future Spouses
If you own a business and you are thinking about getting married, a prenuptial agreement is something you should seriously consider. There is an antiquated stigma against prenups. In 1960, the average age of a married couple was 21.5 years old. By 1990, the average age rose to 23.5 years old. In 2021, the average age of a married couple was up to 34 years old. Today, people are postponing marriage for a myriad of reasons, including higher education, financial stability, and for their careers. Consequently, couples are bringing more assets and debts into a marriage. Because of the stigma, it may seem like a difficult conversation to approach, but there are advantages for both future spouses. Prenups aren’t selfish or adversarial, they are an effective way to protect yourself and your spouse from liability and creditors.
Property and the Marital Community
Arizona is a community property state. The marital community begins on the date of marriage. That means that any assets or debts acquired during marriage, by either spouse, including business assets, are owned by both parties equally.
But that doesn’t mean that everything you own prior to marriage automatically becomes community property. Property is considered to take its character as either community or sole and separate based on when it was acquired, i.e., property acquired before marriage belongs to the spouse who acquired it, and property acquired during the marriage belongs to both spouses.
But just because an asset starts out as sole and separate does not mean it will end up being sole and separate. If community labor (i.e., any work performed during the marriage) goes into the asset, that asset is considered “commingled” (i.e., a mix of community and sole and separate) and will become part of the community estate unless the community contributions can be “traced out.” A business started before marriage but that is also run during the marriage straddles that line precariously.
How a Prenuptial Agreement Protects the Business Owner
A prenup can protect a business owner by separating the business from the marital community. A prenup allows a person to remove certain assets or debts from the marital community. Meaning, the prenuptial agreement dictates how property is treated during a marriage, not community property laws. Further, it can protect a business in the event that the business owner’s spouse gets sued. Since they have no interest or ownership in the business, no one can come after the business for actions done by the non-owner spouse.
To better understand this, let’s consider the effect community property laws have on a business owner not protected by a prenup. Under community property law, if the owner earns money from the business during the marriage, part of the business becomes community property. That means the business you previously owned by yourself (or your interest in the business if you have partners) will now at least be partially owned by your spouse.
In the event of a divorce, the portion of the business that became community property will need to be divided between the spouses. Arizona case law is clear—without a prenup, a business that is operated before and during the marriage is treated as a combination of sole and separate property and community property. See e.g. Cockrill v. Cockrill, 124 Ariz. 50 (1979) (explaining that seldom does a sole and separate asset, such as business, increase during the marriage solely because of the community labor or solely because of the nature of the asset; usually, it is a combination of the two).
Arizona’s approach means that divorce litigation over dividing a business can become complex, entangled, and costly. When dividing a business in divorce, typically, one spouse has been running the business, and the other spouse has had little to no involvement. Most often in those situations, the controversy is resolved by the owner/operator spouse buying out the other spouse’s interest in the business.
That sounds simple but figuring out the buyout amount is where it gets tricky. To determine an equitable buyout, a business valuation is necessary to calculate what that buyout should be. That means an expert valuator is required and it is a process that can take a lot of time and money, leading to a lengthier divorce process. A divorce with a business to divide is often longer, more expensive, and more stressful.
How a Prenup Benefits a Business Owner’s Spouse
A prenup benefits the spouse of a business owner because it shields them from liability for your business. Under Arizona’s community property laws, both spouses are liable for the acts of the other.
When a business owner uses a prenup to opt out of the community property laws, they also opt out of the community being liable for the acts of just one spouse. For example, in Elia v. Pifer, 194 Ariz. 74 (App. 1998), a former client sued an attorney for malpractice and joined (sued) her husband as a defendant (Under Arizona law, when you sue a married person, you must “join” their spouse, i.e., they also are a defendant to the lawsuit because both spouses are liable for one spouse’s actions). Husband produced a prenup to the Court and moved for summary judgment, arguing the prenup effectively shielded him from liability.
The plaintiff argued that Arizona is a community property state and community property can be reached by creditors to satisfy a community debt. Yes, that’s all true, said the Court of Appeals, but a couple can opt out of the community property laws via a prenup.
The plaintiff countered, even if a prenup is valid between the couple, it should not be binding on him, and he should be able to sue the husband too. The Court of Appeals responded by telling him he was mistaken because the prenup made the property each party earned “separate property” rather than community property, and under Arizona law, a spouse’s separate property cannot “be liable for the separate debts or obligations of the other spouse.” A.R.S. § 25-215.
Ultimately, the Court held that a valid premarital agreement prevents the creditor of one spouse from reaching the separate property of the other spouse for a claim that occurred during the marriage.
(As an aside, we note that the first layer of liability for a business owner should always be to incorporate the business, which (in most cases) shields you from personal liability, and the second layer of protection for your business is to insure it).
Prenuptial Agreements are Good for Both Spouses
This article only covered the advantage of prenups for business owners and their spouses, but there are many other advantages for married couples, including: protection from a spouse’s student loans, credit card debts, personal liability, criminal damages, and they can provide security for inheritances, retirement assets, real property, and more. It is time to end the stigma. In 1950, when people were getting married at 21, and only one spouse worked, a prenup seemed inherently unfair. But in today’s world, a prenuptial agreement is simply good business.
If you are already married, you can still get the benefits of a prenup with a postnup. Learn about Post-Nuptial Agreements