New Law Journal – 12 April 2019

Rakesh Kapila examines the forensic accountant’s changing role in matrimonial disputes

In Brief

  • The expert accountant’s role in matrimonial disputes has changed in recent years.
  • In addition to a greater involvement in business valuations, forensic accountants have been more active in assisting in the compilation of questionnaires and in considering the parties’ pension rights.

The forensic accountant has long had an active role in matrimonial disputes arising from provisions in the Matrimonial Causes Act 1973 that the court should take account of the income, earning capacity, property and other financial resources available to both parties to a divorce.

Although a key aspect of the expert accountant’s role in matrimonial disputes over the years has related to business valuations as part of the process of identifying the property and financial resources available to both parties, this article provides an overview of how the forensic accountant’s role has changed in recent years and the primary aspects in relation to which useful work is now undertaken.

Leading Cases

Developments over the last few years arising from case law have resulted in important changes in relation to the split of assets between the parties on divorce. In particular, the House of Lords ruling in White v White [2001] 1 AC 596, [2001] 1 All ER 1 resulted in a change in focus away from the wife’s reasonable requirements and the husband’s ability to pay, to achieving fairness in divorce settlements by recognising the contribution each party has made to the marriage. On this basis, it was noted that, as a general guide, equality should be departed from only if, and to the extent that, there is good reason for doing so, and Mrs Pamela White accordingly received 40% of the family assets resulting in the sale of the family business.

White v White has been followed-up by other ‘landmark’ cases including McFarlane v McFarlane [2006] UKHL 24, [2006] 3 All ER 1 – the House of Lords ruling that the settlement made in court should not just reflect the wife’s needs but, for wealthy couples, compensate her for her losses.

Implications for Forensic Accountants

Matrimonial case law in recent years has had a significant impact on the forensic accountant’s role. The emphasis in the work undertaken by expert accountants has changed as follows:

  • Much work used to be focused on business valuations which were prepared on an ‘overview’ basis in many cases and on calculating the reasonable needs of the wife on the basis of the Duxbury model (Duxbury v Duxbury [1992] Fam 62n, [1990] 2 All ER 77). The approach was particularly useful given that court settlements would not necessitate the disposal of family businesses and ‘needs-based’ settlements had to take account of future inflation and interest rates at a time when such rates were relatively volatile.
  • Work in recent years has included a more active involvement in identifying the financial resources of the parties; a greater number of business valuations which are better informed; and a critical appraisal of the ways in which funds may be secured to effect settlements which do not jeopardise the ongoing viability of the primary business owned by one or more of the parties. Forensic accountants therefore play an important role in valuing family businesses and yet in finding ways of ensuring that such businesses do not always need to be disposed of in securing the resources required to implement agreed settlements.
  • Pension rights in divorce or dissolution settlements can often amount to the largest asset after the equity in the family home if the parties do not have significant business interests. Professional advisers therefore need to pay close attention to this aspect of the ‘family estate’. Negotiated settlements often need to reflect the capital value in present-day terms of the pension rights of one or both parties and there are areas in which solicitors require help from forensic accountants.

The Present-Day Role of the Forensic Accountant

Introduction

The changing role of the forensic accountant has resulted in an increased involvement in the following areas of work as considered in greater detail below:

  • assisting in the compilation of questionnaires after the disclosure of Forms E;
  • valuations of businesses;
  • evaluating pension rights;
  • considering the affairs of businesses or of the parties where financial data is misrepresented; and
  • identifying ways in which funds can be released from businesses.

Compiling Questionnaires

After the disclosure of Forms E – the Financial Statements of each of the parties – the forensic accountant may have an active involvement in assisting solicitors in compiling questionnaires for the following primary reasons:

  • seeking clarification and further information in relation to data provided in the parties’ Forms E or in the supporting documentation, e.g. further information in respect of pension provision, property ownership or the reasons for significant receipts as ascertained from bank statements;
  • obtaining further information to ensure that assets are included at realistic amounts in the parties’ Forms E, e.g. updated valuations and accounts of private companies in which the parties have shares; and
  • obtaining detailed information in respect of businesses identified in the parties’ Forms E with a view towards ‘improving’ the valuation process, e.g. updated financial statements, details of ‘one-off’ income and expenses, usage of businesses in supporting the family’s standard of living and data on management remuneration.

The answers to a first questionnaire could lead to the submission of a second questionnaire to ‘clear’ key outstanding matters. There are instances in which the type of information sought by expert accountants results in early settlements without the need to incur significant costs in court attendance and protracted negotiations.

Valuations of Businesses

The forensic accountant’s ‘traditional’ role is founded on establishing whether businesses should be valued on the basis of their earnings streams, their assets or the dividends paid by them. In order to value a party’s ‘stake’ in a business, it is necessary to value the business as a whole. A business with a consistent history of profits expected to continue as a going concern is generally valued on the basis of its maintainable earnings stream. For a business with a patchy history of profits and with an uncertain future, albeit with a relatively healthy asset base, it may be more appropriate to consider the net assets rather than the earnings stream in valuing the business.

In order to decide the bases underlying valuations, the forensic accountant will need to undertake a detailed scrutiny of the following aspects:

  • the extent to which business profitability has been affected by ‘one-off’ income and expenses or by unusually high levels of management remuneration;
  • the extent to which the net assets of businesses are mis-stated owing to the lack of updated valuations of properties or the extent to which a proportion of net assets is ‘surplus’ to requirement through the inclusion of properties not central to the activities of the businesses concerned; and
  • the shareholdings of the parties and the need to apply discounts to valuations attributed to businesses to take account of minority shareholdings, quasi-partnerships and the types of sector in which businesses are involved.

The Family Procedure Rules provide that wherever possible, one single expert is to be jointly instructed by both parties. On this basis, instructions to forensic accountants to value businesses are often issued on behalf of both parties in matrimonial disputes. This can be beneficial because there is transparency in respect of the information the expert receives, as the letter of instruction must be agreed and signed by both parties. It also reduces the possibility of either party challenging the report if both parties are jointly responsible for the instructions.

Evaluation of Pension Rights

The sum which the parties will wish to take into account in a settlement is the current capital value of part or all of a divorcing spouse’s income stream after retirement, as pensions are simply deferred pay. However, the complications inherent in valuing pension rights are increased by the existence of a large number of different pension arrangements. In particular, different approaches are required to consider the following types of pension:

  • in considering ‘defined benefit’ schemes – i.e. schemes specifying a pre-determined level of retirement benefit, usually calculated by reference to length of service and the level of salary in the final year or years before retirement – the basis of valuation of the pension rights of a member (whether active or deferred) will be the ‘cash equivalent’, i.e. the ‘transfer value’ of the rights; and
  • in evaluating personal pension plans, in which members contribute to funds which are normally managed by pension providers such as insurance companies, although the use of transfer values is appropriate as the basis of valuation, since contributions to personal pension plans are at the member’s discretion, it is not unknown for a party to anticipate a divorce by reducing contributions to his or her pension plan and thus to ‘limit’ the increase in the transfer value of the fund.

After valuing pension rights, the options in broad terms for most couples are (i) to offset the value of pension rights against other assets in a settlement, e.g. one party retains the pension rights but the other party takes a greater share of the equity in the family home, or (ii) to divide the pension rights, either by ‘earmarking’ or pension sharing.

Considering the Financial Affairs of Businesses or of the Parties

Forensic accounting work in relation to the financial affairs of businesses or of the parties may include the following aspects:

  • considering detailed financial information on businesses in which the parties have an interest to identify if there are good reasons to believe that their financial performance or financial position is misrepresented;
  • tracing funds to unearth hidden assets and to ensure that assets belonging to the parties have been stated at the correct amounts;
  • identifying valid information to support significant liabilities;
  • analysing the proportion of assets which relates to pre-marital periods;
  • evaluating the actual income of the parties and their prospective incomes from a family business; and
  • analysing complex transactions to ensure that it is possible to obtain a ‘complete’ financial profile of the parties.

Realising Funds from the Business

Given the greater willingness of the courts to make settlements which may result in the disposal of part or all of businesses owned by the parties, the forensic accountant’s role in identifying ways in which funds may be raised can improve the prospects of businesses continuing to be run by their existing owners. The expert accountant can assist on the following basis:

  • evaluating the prospects of realising funds through the disposal of minority shareholdings, the sale of ‘own’ shares or the raising of funds against shareholdings;
  • considering the cumulative profits of businesses available for distribution and the liquidity available to effect distribution, including a consideration of the ways in which liquidity can be improved, e.g. selling ‘surplus’ assets or raising funds through the provision of property as security; and
  • identifying suitable ways of distributing available funds after taking general tax aspects into account, e.g. by way of remuneration, dividend payments or the repayment of amounts recognised in directors’ loan accounts.

Conclusions

A trend towards the involvement of forensic accountants at an early stage in matrimonial disputes, given one or both parties’ desire for a speedy financial settlement, will be an important factor in enabling such disputes to be settled as soon as possible. It is often the case that, once expert accountants have done their work, agreements become possible with the basic facts having been ascertained and agreed.

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This article was first published by New Law Journal on 12/04/19, and is reproduced by kind permission.

The information contained in our Articles is provided as general information only. It does not constitute professional advice and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances. In addition, since the Articles were published in recent years, the information contained in them may not be applicable at the current time.