Jeremy Sutton: The Ex-Files – Are business debts shared equally?

OPINION:

Q: My wife and I have decided to separate. I work and my wife runs a small business from our home as a sole trader. We do not have significant assets so I thought our separation would be straightforward. However, I have just learnt that my wife has not been paying the correct tax for her business. She now owes significant money to the IRD and will likely also have to pay interest and penalties as a result. I had no idea as I am not involved with the business. Do I have to take on her debt and the additional costs if we separate? What happens if we have more debt than assets to divide?

At the end of a relationship, relationship property will be divided according to the rules of the Property (Relationships) Act 1976 (PRA). Relationship assets are classified as either relationship property or separate property. The same is true of debts, which will be classified as either relationship or personal debt. The legal status of assets owned by a family trust fall outside of the rules of the PRA.

In most cases relationship property will be divided equally between parties. The value of relationship property is calculated by first deducting any relationship debt owed by either or both spouses/partners.

When is a debt a relationship debt?

The PRA defines a relationship debt to be a debt that has been incurred:

• By the spouses or partners jointly; or

• In the course of a common enterprise carried on by the spouses, whether alone or together with another person; or

• For the purpose of acquiring, improving, or maintaining relationship property; or

• For the benefit of both spouses or partners in the course of managing the affairs of the household; or

• For the purpose of bringing up any child of the relationship.

This definition is broad and can capture a lot of spending that incurs debt. Debt that the other party does not know about often falls within the (c)-(e) categories above. Some examples of spending that can fall into one of these categories may include renovations or repairs on the family home, new furniture, landscaping or gardening, new vehicles, travel, household expenses, and children’s school fees.

Any debt that does not fall within one of the above categories of relationship debt will be a personal debt. A common example of a personal debt is a student loan incurred before the relationship began or a debt secured over separate property.

Business debts

Whether your wife’s business debt is considered relationship or personal debt will depend on whether income from her business was used for the household.

If your wife generated an income from her business and that income was used for household expenses or for the benefit of both of you (e.g. on holidays), then any debt that the business incurred would be relationship debt.

However, the business debt could be considered a personal debt if the business is not a common enterprise between you both and the business does not provide income for the household. This may be the case with a start-up company running at a loss. As your wife owes tax to the IRD, this is unlikely.

Penalties and interest

Whether you are responsible for any interest or penalties will depend on your level of involvement with the business. If you helped her out with managing her accounts from time to time, it would be more likely that it could be classified as relationship debt.

However, in a case previously before the Family Court it was decided that if one party has no knowledge of the lack of disclosure to the IRD, then any interest or penalties incurred are personal debts and therefore do not affect the pool of relationship property.

What if the debt is larger than the relationship property pool?

It is possible if your relationship property pool is only modest that a large debt may have a significant impact on you. If the property pool is negative after debts have been deducted, those debts will still need to be divided between you. Usually, under the rules of the PRA, this division will be 50/50.

However, it may be possible to argue there should be unequal sharing where there is a negative value. Unequal division can be ordered if it would be repugnant to justice to order equal sharing in the circumstances. This threshold is extremely high and very difficult to establish. In a recent case, the Family Court allowed this exception when the extent and consequences of the failure to declare company transactions correctly to the IRD meant the value of relationship was negative.

Summary

The definition of relationship debt is very broad and often captures many debts incurred by one party without the other’s knowledge. However, each case is highly dependent on the unique circumstance of the relationship. Advice from a family lawyer is very important to ascertain an accurate assessment of your circumstance.

Jeremy Sutton is a senior family lawyer, specialising in divorce cases where there are significant assets, including family trusts and complex business structures.

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