Incentive plans in divorce
Incentive plans in divorce: How the Family Court divides more complex remuneration packages
When couples separate, dividing assets like the family home or pensions may seem straightforward. However, for many senior professionals, their incentive plans are more complex involving not only bonuses but also deferred shares or carried interest. This means understanding how to treat incentive plans in divorce is critical.
These plans can carry huge value, but their complexity and future-based nature make them some of the most difficult assets for family courts to divide.
What are incentive plans?
Incentive plans are employment-related rewards awarded in addition to base salary to recognise long-term performance or length of service. Common types of incentive plans include:
- Performance bonuses (annual or discretionary)
- Long-term incentive plans (LTIPs)
- Deferred share or stock option awards
- Carried interest in private equity or investment funds
- Retention or profit-linked cash schemes
These plans may vest (the term used to mark when the employee can access the financial reward set out in their inventive plan) over several years dependent on performance, profitability or continued employment.
This means their value at the point of divorce is often uncertain which in turn creates unique legal challenges should the incentive plan become part of a divorce negotiation.
Fairness and the ‘matrimonial pot’
The guiding principle of English family law is fairness, as established in White v White [2001].
Section 25 of the Matrimonial Causes Act 1973, outlines the factors the Family Court must consider when making financial orders during divorce proceedings.
On this topic, the court will pay particular attention to:
- Financial needs, obligations and responsibilities: ensuring both parties (and any children) have suitable housing, income and financial security.
- Contributions to family welfare: recognising where one party has given up a career or earning capacity for the benefit of the marriage - often occurring in circumstances where one party leaves employment to take on the role of the main caregiver to the children of the family
The Court will also consider the ‘sharing principle’; dividing wealth built during the marriage equally unless there is a good reason for it to be divided in another ratio.
Assets accumulated during the marriage are usually considered to be ‘matrimonial’ and, therefore, available for sharing. Assets gained before or after the marriage or through inheritance can, however, be classed as ‘non-matrimonial’. The challenge lies in identifying which category incentive plans fall into, particularly when vesting and performance conditions cross the separation date.
Disclosure: The starting point with incentive plans in divorce
Incentive-based remuneration can only be fairly divided if both parties fully disclose what they hold. Each party must complete a Form E which is a Statement setting out a parties’ financial position. This contains details of all assets, liabilities, income and potential entitlements and requires supporting documentary evidence
For incentive plans in divorce, disclosure must include:
- Plan rules and grant letters
- Vesting schedules and performance conditions
- Tax treatment and anticipated payout dates
- Correspondence about award levels or targets
It must be stressed that full and transparent disclosure is vital. Omitting any details risks unfair outcomes or even the need to pursue formal financial orders through the court later.
How does the Family Court approach incentive plans in divorce?
When assessing incentive plans, the Court considers timing, nature and fairness. To do this some key questions will need to be answered.
Firstly, when was the award earned or vested? Awards that vest during the marriage are generally treated as matrimonial and subject to division. Awards that vest after separation may still be partly matrimonial if they reward performance during the marriage. However, if ongoing work or performance post-separation affects vesting, only the proportion relating to the dates the couple were married is likely to be matrimonial and subject to division.
They’ll also need to understand the nature of the incentive plan. Guaranteed or contractual bonuses are easier to quantify and divide but discretionary or contingent awards, such as LTIPs or carried interest, are more speculative and require expert valuation.
How incentive plans should be divided is another key issue. Courts seek practical and fair outcomes rather than rigid formulas and will also use certain accepted approaches including:
- ‘Offsetting’, one spouse retains the incentive plan while the other receives a larger share of the other assets like property or cash.
- ‘Lump-sum compensation’, a cash amount reflecting the value of the plan.
- ‘Wells sharing’, a principle based on the decision in Wells v Wells [2002]. The court awards a percentage share of future payouts as they arise, allowing both parties to benefit proportionally when the award eventually pays out.
Common challenges around the division of incentive plans in divorce
Because of their complexity, the division of incentive plans in divorce does give rise to some fairly unique legal challenges.
Accurate valuation is one of the challenges which may arise. Many incentive plans rely on market performance or business success, so expert financial input is often required to assess current and projected value.
There is also often an issue around knowledge and understanding. The person involved in the plan will very likely have a much better understanding of their incentive scheme than their spouse. This knowledge will therefore need to be evened out and shared
Courts must also be able to ascertain and separate the value earned during the course of the marriage from any value created post-separation through continued work or market growth and in turn do what they can to ensure a clean break to avoid future legal entanglements for the couple. The desire for a clean break can make a Wells-style order less attractive and direct the discussions towards offsetting instead.
Arguably the biggest challenge is simply that incentive plans in divorce are no longer rare. They are now central to many modern financial remedy cases, particularly those with a higher net worth given the way senior executives are increasingly being remunerated and rewarded.
Unpicking their complex demands specialist legal guidance and careful strategy. However, at the same time, perhaps the key takeaway for those facing the challenge of dividing an incentive plan as part of their divorce is that not all income is regarded as equal. Incentive plans carry risk, delay and uncertainty but the Family Court recognises this. With transparent disclosure, professional valuation and experienced legal advice, it is becoming more straightforward to reach a settlement that reflects both fairness and practicality.
If you are facing divorce and your assets include incentive plans, our family team can help you understand your rights, protect your interests and achieve a balanced resolution. Contact us online here, or call us on 0114 266 6660
