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February 9, 2021

Should Business Owners Ask Their Children—the Next Generation—to Sign Prenuptial Agreements?

Should a business owner and spouse ask their children, or the next generation, to sign prenuptial agreements with their future spouses? If yes, what terms should the prenuptial agreement include and what would the process look like? Related questions are: What is the marginal risk protection a prenuptial offers above shareholder, operating, or stock restriction agreements? What risk is the business exposed to if each child or next generation makes an independent decision about whether to enter into a prenuptial agreement? What are the relational and emotional impacts these agreements might have, and do the benefits outweighs these risks?

First, some general concepts. Prenuptial agreements essentially are concerned with two events: death of a spouse and divorce. If there is no prenuptial agreement, the state in which the couple resides has rules that apply if there is a death or divorce. The prenuptial agreement just changes those rules. So we like to say when you get married, there is a contract in place (the applicable rules of the state in which you live). However, most people who are getting married don’t know what those rules are. A prenuptial agreement makes the rules explicit.

On death, the surviving spouse is entitled to an elective share of the assets of the deceased spouse. In New York State, this elective share is one-third, and in Florida it is 30 percent. Most, if not all, states provide for an elective share. The elective share applies to all assets, including inherited and gifted assets, property acquired prior to or after the marriage, business interests, probate assets, retirement benefits, and more. Some states, mainly in the West, have community property rules that also provide spouses with rights to assets. The elective share applies immediately upon marriage and does not depend on the length of the marriage. Hence, the lightning bolt example of a spouse dying right after the marriage ceremony and the new spouse’s entitlement to a significant share of the deceased spouse’s assets, with the probability that those assets will end up outside of the family in the hands of the surviving spouse and children of the new spouse.

On divorce, each spouse is entitled to a share of the marital assets depending on the length of the marriage. This is called equitable distribution in New York State and Florida. Community property states have different rules, but assets will still be split between the spouses. Separate property is not subject to equitable distribution and is generally defined as: a) property already owned at the time of marriage and b) gifted or inherited property. Note that if family business interests are purchased by the next generation instead of gifted, the family business interest is considered marital property not separate property. So the way a business succession plan is structured may have a significant impact on the implications of a divorce. Also, appreciation in value of the gifted or inherited property after the marriage may be considered marital property based on the efforts and contributions of the owner or the owner’s spouse. So the definition of separate property is the key to a lot of what is included in the prenuptial agreement.

In addition, in the event of divorce, there is the issue of whether one spouse may obtain maintenance, or an income stream, from the other for life or a term of years. This may be based in part on the income generated by the family business.

So how can the potential consequences of death or divorce, especially the effects on the primary business and related businesses, be mitigated without doing a prenuptial agreement?

  1. Buy-sell agreements for businesses should be in place before death or divorce: The shareholders’ agreement for the operating business and related entities often state that if the shares are subject to claims (such as a spouse’s claim on divorce or death against the estate), and the shares do not clearly pass at that time only to descendants or a spousal trust, the company and remaining owners have the option to buy those interests at a discounted value, in installment payments over say, 15 years, at an interest rate equal to the lowest rate allowed by the IRS. So the spouse, on divorce or death, will get some value for the business, just at a potentially lower value and on a restricted basis. Also the business must be appraised, which can be a disruptive process for the owners and the business itself.
  2. Gifts and inheritances in trust for descendants and not outright: Instead of giving business interests (and inheritances generally) outright to the children or other descendants, consider in your wills or gifts putting the assets in trust for your children and other descendants. For example, since the business interest is not owned directly by the child but rather by the trust, the child’s spouse has no elective share claim against the business interest and, in the event of divorce, has no claim for the value of the business because it does not belong to the child.


Putting the business interests and other assets in trust under your wills or when you make the gift not only potentially protects the business and other gifts from a) spousal claims on death or divorce, but also b) estate tax on death of the child or other descendants, c) creditor claims generally, d) and ensures the business interests and other gifted or inherited assets pass on death of the child or other descendants or on divorce only to the descendants. As to the last benefit, the child or descendant can have the power to change the distribution of the trusts on their death, but this can be limited to the descendants, spousal trusts, or as the business owner otherwise determines.

Having a prenuptial agreement in place provides the most flexibility for the child or descendant entering into a marriage, as well as for the parents and grandparents of that child or descendant. Depending on the value of assets, estate tax environment, nature of the business interests, and other assets, the parties have more freedom to establish their estate and business succession plans in the best interests of the business and their families. For instance, by the child having a prenuptial agreement in place, the parents may choose to give voting interests in the family business outright to the child instead of in trust because they know the voting interests will be protected by the combination of the prenuptial agreement and the business buy-sell agreement.

Most people think of prenuptial agreements as a complete separation of each spouse’s finances so that on death or divorce, each spouse will be left only with assets in that spouse’s name or income earned by that spouse. This separation of assets and income is generally the goal for spouses who marry later in life who may have adult children from prior relationships, and who are financially independent. Each spouse agrees to waive claims against the other in the event of divorce or death. In the case of a young couple starting out where one or both are involved in family businesses or have wealth acquired prior to the marriage or who will inherit wealth, the situation is vastly different. The prenuptial agreement should be customized to the situation and to the judgement of the child and that child’s family family. For instance, the agreement can be limited to the family business interests. So separate property can be defined as the family business, no matter how acquired—whether by gift, bequest, or by purchase—including all appreciation in value and income, whether generated before or after the marriage and regardless of the extent of the contribution and efforts of the spouses. Alternatively, the prenuptial agreement can be broader to include all gifted or inherited property. In those instances, the prenuptial agreement can provide that the separate property, defined as the family business interests or all gifts and inheritances, will be separate property not subject to spousal claims on divorce and also not subject to the elective share on death.

The process of talking about and implementing a prenuptial agreement can be extremely emotional for the couple and their families. It often devolves into an issue about whether the future spouse seeking the prenuptial really trusts, loves, and cares about the other. The emotional concerns can be addressed in part if everyone involved understands that without a prenuptial agreement, the state government sets the terms of the marriage, which is similar to a contract. So the question is whether the couple wants to design that contract instead of being bound by the state’s terms. The primary concern of the person being asked to sign a prenuptial agreement and who does not come from a family with a family business or wealth is financial security. It is critical that this spouse feels that they will be financially secure in the event of divorce or death. We recommend each couple consider obtaining significant life insurance sufficient to generate the income the surviving spouse and children will need to live at the expected customary standard of living during the marriage. The level of insurance could consider that over time the couple will build marital assets, such as retirement plans, as well as educational funds for their children, which will be freely available to both spouses.

Note the prenuptial agreement sets out certain rights and responsibilities, but except as may be restricted by buy-sell agreements, does not prevent the child or other descendant from making transfers of assets into joint name or the spouse’s name either during life or at death. So the trust for the child or descendant discussed in the second scenario above is still a relevant option even if the couple signs a prenuptial agreement.

This discussion focuses on prenuptial agreements entered into before the marriage. Note that married couples may also enter into an agreement covering the same topics. This is generally called a postnuptial agreement. Courts do not favor agreements between spouses or future spouses. Accordingly, in order for a prenuptial (or postnuptial) agreement to be enforceable, there must be full and complete disclosure of finances. In addition, each spouse must be separately represented by counsel. Some of the disputes arise when separate counsel is engaged and explains the implications of the prenuptial agreement. A thorough understanding by all parties of the terms and implications before engaging counsel may alleviate this risk, as everyone will have a general understanding ahead of time and will not be taken by surprise.

One important provision we include in the prenuptial agreement between a couple with potential wealth and liability for federal or state estate taxes on death, is to require the executor or fiduciary for the spouse who dies first to cooperate with the surviving spouse to preserve the portability of the deceased spouse’s estate tax exemption (often referred to as the DSUE) for the benefit of the surviving spouse. This can save significant taxes without cost to the spouse who dies first.

Each family within the extended family may have a different perspective and make a different decision as to whether or not to ask their children to sign prenuptial agreements with their future spouses. However, differences may generate resentments among family members. The more the extended families have shared values and objectives and collaboratively work together on these issues, the less the risk of dispute and conflict. Coming to a consensus on what the prenuptial agreement should cover and perhaps even a baseline template may be helpful.

Formally planned family gatherings can be a perfect opportunity to address financial literacy matters with your children. The financial agenda could include the benefits of prenuptial agreements and how they actually work rather than how they are often portrayed in the media. The prenuptial agreement could be included as part of a larger discussion, including how to build marital assets for financial security, warning not to commingle family gifts and inheritances with marital property, how to create a diversified investment portfolio, and other financial issues of interest to the family.

We hope this summary sheds some light on this complex and multifaceted topic. We are happy to engage in workshops or discussions with you and your family.

If you have any questions regarding this blog, please contact Karen Schaefer, Trusts & Estates Practice Area co-chair, at kschaefer@barclaydamon.com, or another member of the firm’s Trusts & Estates Practice Area.

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