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24th February 2024

Richard Kershaw explores private equity interests on divorce in The Law Society Gazette

Richard Kershaw explores private equity interests on divorce in The Law Society Gazette

Richard’s article was published in The Law Society Gazette, 23 February 2024, and can be seen here.

Sharing private equity interests on divorce

When dividing assets on divorce, it is sometimes necessary to consider not only the proportions in which an asset is to be shared, but how and when the division should happen. This often arises where an asset is difficult to value and cannot be sold – such as a private equity fund manager’s entitlement to carried interest, as explored in Cohen J’s recent judgment in ES v SS [2023] EWFC 177.

There are two basic options in such circumstances: estimating the asset’s value and providing for the asset-holder to buy out the other’s interest; or postponing division until the asset is realised, at which point a percentage of the proceeds is paid to the other party. The latter approach is known as ‘Wells sharing’, after the Court of Appeal’s decision in Wells v Wells [2002] EWCA Civ 496 (although it was not in fact the approach taken in that case).

In Wells, the husband’s business was in difficulty such that there was no realistic prospect of sale, making valuation impossible. The original judgment awarded most of the family’s property to the wife, leaving the husband with his business and limited other assets. The Court of Appeal overturned this decision, holding that there must be ‘a fair division of both the copper-bottomed assets and the illiquid and risk-laden assets’, and varied the outcome to give the husband a greater share of the ‘copper-bottomed’ assets to reflect the business’s vulnerability. Thorpe LJ had raised with the parties the prospect of transferring some of the husband’s shareholding to the wife, so as to achieve a more balanced division of risk. This was, however, opposed by both parties, not least because of the tax liability it would have created; the husband was also concerned about the potential for the wife to interfere with the business.

The ongoing financial nexus between the parties required by Wells sharing is one reason the courts have generally preferred to avoid it. Under section 25A of the Matrimonial Causes Act 1973, the court is required to consider whether its order should provide for ‘the financial obligations of each party towards the other [to] be terminated as soon after the making of the order as the court considers just and reasonable’ (known as the ‘clean break principle’).

In Versteegh v Versteegh [2018] EWCA Civ 1050, the wife had been awarded a minority share in the husband’s business as it was difficult to value. King LJ identified that Wells sharing should be ‘approached with caution’ after ‘full consideration’ of the clean break principle. Lewison LJ approvingly cited Mostyn J’s determination in WM v HM [2017] EWFC 25 that ‘generally a Wells sharing arrangement should be a last resort’. They did however conclude that the judge could not be said to have been ‘wrong’ to make a Wells order, notwithstanding that they considered it ‘unattractive’ and a ‘very unsatisfactory outcome’. In A v M [2021] EWFC 89, a private equity case, Mostyn J held that where there is to be Wells sharing ‘it should be limited as much as possible both in its size and in its range’.

ES v SS [2023] EWFC 177 serves as an important reminder that Wells sharing will sometimes be the best outcome. The husband was a private equity fund manager entitled to certain payments on the sale of various investments, dependent on the sale prices achieved. Forensic accountants were instructed to estimate the husband’s likely receipts. The speculative nature of such valuations was starkly demonstrated when, during proceedings, one such investment – E Co – was sold, realising a payment to the husband of €49.9m. This was 10 times more than the value that had until then been attributed to that interest.

Naturally, the wife was thereafter reluctant to accept that her share of the husband’s interest in the remaining investments should be based on such valuations. Nevertheless, this was the position the husband advocated, arguing that ‘unforeseen external forces’ were responsible for the situation which had arisen with E Co. As Cohen J commented: ‘I do not need to go further than to say that there is clear scope for events, whether foreseeable or not, to lead to a valuation being significantly out, with the risk of injustice to one or other party.’ The husband also argued that a Wells approach was contrary to the clean break principle and suggested that an order for future sharing had ‘potential for continued argument and ill feeling’ between the parties. Cohen J rejected this: it would not be ‘an onerous burden’ for the husband to provide the wife with annual statements in respect of the investments and full details of any exit.

Overall, Cohen J concluded: ‘It would be wrong for me to overlook the potential for H to receive a very much larger sum from these entities than the current valuation, or indeed a lower sum. It would be wrong of me to ignore the history of the E Co exit… In circumstances where W is entitled to a share in the assets and where any exit is likely to take place within a relatively modest timescale, this is the best – indeed the only – way of doing fairness between the parties.’

Arguably, this will often be true for private equity interests, even if it is rarely the case for private businesses. In private equity cases valuations of future receipts are highly speculative, there are no implications for the business of a Wells sharing approach, and it requires limited ongoing contact between the parties. As Cohen J said, it may well be the only fair approach.

Hunters Law LLP acted for the applicant wife in ES v SS [2023] EWFC 177.