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Carry On Divorce

Are you a fund manager? Are you married or do you intend to get married? Ever wondered what would happen to your carry if you were to get divorced? Whether the funds in question are onshore, offshore, in private equity, hedge funds or venture capital - this is what you need to know…

On a divorce in England and Wales there is an entitlement to share capital built up during the marriage, but there is no entitlement in law to share an ex-spouse's future income. So, is carry to be treated as future income, or capital? To be thrown in the marital pot and shared, and if so, in what proportions, or does the earner get to keep it all?

There are a couple of reported judgments from the Courts that offer some guidance: 

  1. In the case of B v B [2013] EWHC 1232 (Fam), the husband was a fund manager, with carry in Funds A, B and C. The husband and wife had agreed that rather than the wife being bought out of her share of the carry, she would receive a percentage of the net amount as and when the husband received it, but the question was what percentage (if any) she should receive from each fund. In the judge's view it wasn't possible to apply a strict methodology to determine the answer. 

He said "To achieve fairness it is necessary to recognise fully the tension between the fact that the wealth was in part generated by the use of expertise built up during the marriage and in part by the expenditure of effort after the separation. Both elements are important. I do not think this part of the case can be analysed precisely either by reference to the time involved in each phase of the process and/or its relative importance. It is a product of both to some extent ".

From the conclusion the judge in this case reached, it seems that there were three important questions to consider when deciding what the wife should get, at the date of separation:

(1) was the carry fully vested;

(2) how much of the fund was invested; and

(2) had the hurdle rate of the fund been achieved. 

All of the judge's holistic considerations led him to conclude, without any numerical formula, that the wife should receive the following percentages of carry as at the date of trial:

  1. 50% in Fund A (at the date of separation: carry fully vested, fund fully invested and hurdle met);
  2. 20% in Fund B (at the date of separation: carry fully vested, fund largely invested, but hurdle not met); and
  3. 0% in Fund C (at the date of separation: 40% of carry vested, fund barely invested, and hurdle not met).
  1. In the more recent case of A v M [2021] EWFC 89, a different judge took a far more strict mathematical approach.   The judge devised a formula calculated linearly over time, which looked at the term of the fund, and the date of the first and final close, to determine the marital, and therefore shareable, element of the carry.
Adele Pledger
Adele Pledger

The formula was A ÷ B = C% whereby:

  • A is the period (measured in months) from the establishment of the fund to the date of the trial;
  • B is the number of months from fund establishment to first close plus the estimated term of the fund; and
  • C is the marital fraction of the fund manager's carry, expressed as a percentage.

The projected value of the fund manager's carry is then multiplied by C% to give the marital carry, and the spouse should receive 50% of that amount when it is received. 

It's always easier to understand formulas in action with a worked example, so here you go:

In the case in question, the husband had carry in Fund 1 and in Fund 2. 

Fund 1 was established in October 2016. The trial was in November 2021 (60 months after the fund was established).  The fund's first close was in March 2017 (5 months after establishment). The estimated term of the fund was 9 years/108 months. Therefore, for Fund 1: A = 60; B = 5 + 108 = 113; and C = 60 divided by 113 = 53%.  The wife should get 50% of 53% = 26.2%.

Fund 2 was established in October 2018 (36 months before the trial). Its first close was in June 2019 (8 months after establishment), and it’s term was deemed to be 9 years/108 months. Therefore, for Fund 1: A = 36; B = 8 + 108 = 116; and C = 36 divided by 116 = 31%. The wife should get 50% of 31% = 15.5%.

The judge was sympathetic to the husband's reluctance to his wife being a shadow partner in both funds, rather than just one, and so did a further calculation, taking into account the fact that Fund 2 is projected to yield 38% more carry value than Fund 1, to work out what her share should be of Fund 1 only (on the basis she wouldn't then get a share of Fund 2). The calculation sought to adjust A in Fund 1 in the above formula by reference to the longer term in Fund 2 and anticipated higher yield. So the recalculation for the wife's share in Fund 1 was as follows:

Fund 1 A + (Fund 2 A multiplied by the % difference in value between Fund 1 and 2) = the new 'A' to slot into the above formula for Fund 1. So, on the basis that the figure for A in the Fund 1 formula was, as we know from above, 60, and for Fund 2 A was 36, and the projected estimated value of Fund 2 carry was 38% more than Fund 1 carry, the calculation was:  60 + 36*1.38 = 110. Thus, the revised A figure for Fund 1 is 110, B remains 113 per above, meaning C is 110 divided by 113, which equals 97.06% (50% of which is 48.53%). And so rather than receiving 26.2% of Fund 1 and 15.5% of Fund 2, the wife ended up receiving 48.53% of Fund 1 and 0% of Fund 2.

One thing that is clear from the above cases (neither case takes precedent over the other as they are both at the High Court level) is that different judges will apply different approaches when considering how to tackle these cases, and unfortunately you can't pick what judge you'll get in Court.   

With this in mind, are there any actions that fund managers can take to try to protect their carry? 

Here are my top tips:

  1. If you're not yet married, enter into a pre-nuptial agreement prior to marriage, and address what happens to carry in that agreement.
  1. If you are already married, you could always get a post-nuptial agreement, addressing what should happen to that carry in the event of divorce.
  1. If you have concluded you want a divorce, don't delay.  The sooner it is objectively clear you have permanently separated, and the sooner you're able to resolve financial claims (and if necessary, get to a court trial), the less carry your spouse would have a claim to.  Note that in the case of A v M, the divorce petition was issued in July 2019 and the trial wasn't until November 2021, and it was the date of trial that was relevant in the formula, not the date of separation.  Whereas in B v B, when addressing how much carry the wife should get, the judge was more concerned with the status of the funds at the date of separation.
  1. Instruct a bright lawyer, who has experience of cases involving carry. 
  1. Consider if it is possible, and if you would prefer, to try to offset giving your spouse a percentage share of the carry, and instead give them other assets/money in lieu.
  1. If further significant work by you is required on the fund, and/or there are performance clawback provisions, make it clear and provide details - to your lawyer and your spouse.  
  1. If your spouse is going to receive a percentage share of the net carry, ask your lawyer to get input from a corporate lawyer on the drafting of the clauses in the divorce order.  Clarity in drafting can avoid further disputes down the line. 


Adele Pledger is a Partner in the Family team at Withers LLP in London


The views expressed in this article are those of the author and do not necessarily reflect the views of AlphaWeek or its publisher, The Sortino Group

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