When family and business collide: Managing disputes before they escalate

Family businesses come in all shapes and sizes, from small farming partnerships to large corporate groups. Despite this diversity, certain themes recur, and one of the most significant is a heightened potential for internal conflict.

Why family businesses are particularly prone to disputes

Family businesses are more likely than other businesses to operate according to unwritten rules and informal understandings about how the business should be run. Common examples include expectations that:

• the business exists for the wider benefit of the family, not just those directly involved in running it;
• dividends or income will be distributed to shareholders broadly;
• family members working in the business can expect to inherit a larger share of it in due course.

These understandings can take practical precedence over formal documentation, and that tension can itself be a source of conflict. Layered beneath the business understandings are all the complex personal relationships found in any family group. The combination of undocumented expectations and personal dynamics creates scope for disagreement, with disputes carrying an edge because of those family ties.

Common causes of conflict include:

• the exclusion of some family members from involvement in the business;
• dealing with underperforming family members;
• misbehaviour, including treating the business as a personal resource;
• disagreements about whether to prioritise short-term income or long-term capital investment.

These are all commercial disputes core, but they are sharpened by underlying family relationships, whether inter-generational friction, or sibling rivalry.

Quasi-partnerships and legitimate expectations

Family-owned companies are often textbook examples of what lawyers call “quasi-partnerships”. Although they are formal corporate entities governed by documents such as articles of association, they are shaped by informal understandings about how the business will be run, and the Court can enforce those understandings under certain circumstances.

English law holds that in “unfair prejudice” claims, shareholders may have “legitimate expectations” that go further than their strict rights under the articles. In a family business, these might include expectations that:

• shareholders will have a voice in strategic decisions;
• dividends will be paid irrespective of any individual shareholder’s contribution;
• family members will be entitled to employment;
• certain benefits, such as private healthcare, will be available to family shareholders.

Where such expectations are not honoured, affected shareholders may apply to the court for a remedy (typically, the purchase of their shares at fair value) on the basis that they are being unfairly prejudiced.

There are, however, limits to this principle. First, expectations do not automatically pass down through the generations. Children or grandchildren of a founding shareholder may find that the same understandings do not extend to them. Second, the conduct of the shareholder bringing the claim will be examined closely. The weaker the claim to a legitimate expectation, the easier it becomes to justify departing from it on commercial grounds. A second or third-generation family member who expects a role in the business may find that expectation carries little weight if they lack the requisite ability or have acted improperly.

Prevention is better than cure

Litigation is a blunt, expensive, and stressful tool for resolving family business disputes. The best steps are those taken in advance.

Articles of association based on the Model Articles lack mechanisms to deal with misbehaving directors or shareholders, or to provide a fair exit route for those wishing to realise their investment. Such provisions can be included in the articles, but are often better placed in a bespoke shareholders’ agreement, which is private between the parties and can set out the rights and responsibilities of shareholders in greater detail.

The difficulty is that shareholders’ agreements, focused as they often are on what happens when things go wrong, are not commonly found in family businesses. They can feel like a pre-nuptial agreement: an acknowledgement that things may not always be straightforward, which people naturally prefer not to dwell on.

A less formal alternative is a family charter. These are not intended to be legally binding, but they set out an understanding between family members about how the business is to be run, which reduces the scope for future disputes and, if disputes do arise, provides a clearer basis for resolving them.

A good moment to address these matters is when the baton passes from one generation to the next. With the right documentation in place, the next generation may thank their predecessors for the foresight of having done so.

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