Article April 18, 2023

Common-law partners in business: preparing for the worst to love each other in peace

Operating a business as common-law partners is a bit like being in a couple twice. It’s best to be aware of all the elements that will protect both partners and their business in case of a setback.

Before thinking about resolving business issues, common-law partners need to get their personal lives in order. “It’s very important to have a cohabitation agreement if you’re two de facto spouses running a business together,” says financial planner Patrice Gascon. This contract between unmarried partners makes it possible to define the division of responsibilities, the representation of one of the spouses in certain situations (power of attorney), the measures to be taken in the event of separation or death (division of property and income, alimony or compensation, etc.).

However, this agreement does not replace a will or a power of attorney in case of incapacity of one of the partners. In addition to these important documents, de facto business partners should pay particular attention to insurance, especially disability and critical illness insurance. “If one spouse becomes ill and the other must spend a lot of time caring for them, it can weaken their business,” says Patrice Gascon. “You need to have insurance in place for that eventuality.”

He notes that common-law partners in business take on certain financial risks. Since they are not employees, neither is eligible for the protections of the Commission des normes, de l’équité, de la santé et de la sécurité au travail (CNESST). Some will not contribute to the Régie des rentes du Québec either. “The role of the advisor is to show them these blind spots and ensure that their personal financial security is as solid as possible,” says Patrice Gascon.

The shareholders’ agreement

The spouses should then draw up a shareholders’ agreement, for corporations, or a partnership agreement (for example, in the case of a general partnership). “These agreements allow you to determine how certain situations will be handled, such as the voluntary departure of a shareholder, the death of one of the partners or the bankruptcy of the company,” says Jean-Simon Deschênes, a partner in the business law group at Langlois Avocats.

These agreements are designed to protect each shareholder and promote business continuity. This is important in the case of common-law spouses, as federal divorce law does not recognize such relationships. In the event of separation, the two partners are not legally considered spouses, only shareholders,” explains Deschênes.

Thus, in the absence of an agreement providing for the departure of one of the shareholders, the two ex-spouses could well find themselves in a dispute. One spouse could ask the court to liquidate the company or claim oppression by a shareholder (i.e., unfair, or abusive behavior toward a shareholder). “Either way,” the attorney warns, “there is a high risk that former spouses will end up in court. It is best to plan for this type of situation in a contract at the outset.”

In case of separation

“The shareholder agreement also clarifies how the value of the business is assessed and what each person brings to the business and how much income they receive from it, which can be a sensitive issue between partners,” says Hélène Marquis, Executive Director, Tax and Estate Planning at CIBC Private Wealth Management. There are two income issues that should be of particular concern to common-law business partners, says Marquis. First, they should resist the temptation to allocate income simply based on what appears to be the most tax efficient. “If one partner is running the business full time and the other is answering the phone 20 hours a week, but they’re both making the same salary, the tax authorities may come calling,” she says. So, the income distribution should be reasonable in relation to each partner’s commitment to the business.

On the other hand, there may be times when one partner’s work, while not directly involved in the business, allows the business to flourish or encourages the other partner to become more involved in the business. For example, one partner may spend a lot of time organizing networking activities, meeting with clients at home, etc. This also occurs when one spouse does a lot of the housework and takes care of the children to free up time for the other to spend on the business. “Some court decisions have allowed spouses to be compensated during a separation because their behind-the-scenes work helped the other spouse get rich and make their business thrive,” says Hélène Marquis. These “unjust enrichment” rulings have multiplied over the past 15 years, even for common-law spouses.

Will or shareholder agreement?

The death of a partner can also affect a business owned by a couple. Jean-Simon Deschênes reminds us that while the will is an important document for business partnerships, the consequences of the death of a partner should also be dealt with in the shareholders’ agreement. A will can be modified by one partner without informing the other, but not a shareholders’ agreement,” he explains. “It can only be amended with the consent of all parties. It is therefore a more secure document, for example, to determine who will receive the shares of a deceased partner.”

IN CANADA, 22,7 %

Source: Statistics Canada

Given the breadth of elements they must consider, common-law partners in business should have a trusted advisor with an overall vision and in-depth knowledge of their situation, which is not always the case. “They often consult an accountant or a tax specialist on a piecemeal basis to manage specific elements such as incorporation, but they don’t necessarily have an advisor to guide them in a more general way,” Patrice Gascon laments.

For her part, Marquis stresses the importance of keeping these contracts and insurance coverage up to date. They must be reviewed regularly to ensure that they still reflect the current situation of both spouses and the evolution of the business,” she says. This is essential to ensure that the couple and the business remain well protected.

For more information

Shareholders’ Agreement, Enterprise Québec (in French only)

Breakdown of a de facto union, Justice Québec