Reducing the risk of disputes in family businesses

Family businesses come in all shapes and sizes. From small farming partnerships to large companies.  Despite this diversity there are some common themes in family businesses, including a greater likelihood of internal conflict arising.   The reasons for this and thoughts on how to mitigate it are set out below.

The first point is that family businesses are more likely than other businesses to have unwritten rules or understandings about how the business should be run.  Examples which are often seen are that:

• the business will be viewed as for the wider benefit of the family, not just for those directly working within it,
• there will be a focus on dividends or income to be distributed to the wider shareholders in a company,
• that family members working in the business can expect to inherit a larger proportion of the business in due course.

These understandings overlay, and on a day to day basis often take precedence over, more formal documentation which govern relationships between the parties in the business.  This can be a cause of conflict itself.

In addition, underneath these business understandings are all the complex personal relationships which are found in any family group.

This combination of undocumented understandings plus more intense personal relationships means that there is enormous scope for disagreement about how the business is run.  These disputes have an added edge because of the family relationships.

Some examples of common causes of disputes within family businesses are:

• the exclusion of some family members from involvement in the business,
• dealing with underperforming family members,
• misbehaviour, including using the business as a personal piggy bank,
• disagreements about whether the focus should be on short term profit or long term capital investment (often setting the older family members against the younger).

These all have commercial elements, but are exacerbated by the underlying family relationships.  That can be inter-generational, with older members having different priorities to younger ones, or good old fashioned sibling rivalry, which is often not far from the surface even if long suppressed.

These sorts of disputes cannot therefore be avoided, but the risks from them can be reduced.

The best steps are always those which are taken in advance, prevention being better than cure.  The right documentation can reduce the scope for disputes and if disputes arise there can be built in mechanisms to help resolve them.

It is often a false economy to rely on standard documentation.  For example, Articles of Association based on the Model Articles are perfectly adequate for most purposes, but they lack mechanisms to deal with misbehaving directors or shareholders, or to provide a fair exit route for those who want to cash out of the business.

Such provisions can be added into the Articles but are often better placed in a bespoke shareholders’ agreement which is private between the parties. These can be much broader in setting out the rights and responsibilities of shareholders.

However, the nature of such agreements, which are often very focused on what happens when things go wrong, means that they are not often found in family businesses.  They have the same feel as pre-nuptial agreements, anticipating that things may not always be rosy, and people generally don’t want to think about that prospect if they can help it.

A step down from shareholders’ agreements are family charters / family constitutions.  These are less formal in nature and not intended to be binding in a legal sense.  They do have value as if they commit to paper the understandings between family members about the way the business is to be run then this will reduce the scope for disputes.

The key point to take away is that the law can be a very blunt, and a very expensive tool to resolve the sort of disputes that are prone to arise family businesses.

There are steps that can be taken to reduce the risks and these should be considered at an opportune moment.  Just such a moment is the passing of the baton from one generation to another.  The next generation may then come to thank the previous one for their foresight in putting in place a well drafted shareholders agreement.

How we can help

If you want to talk about a shareholders agreement or other steps to reduce the risks of disputes, or if a dispute is already brewing, then please contact our shareholder disputes team.