Future Proofing, Or How One Family Business Ended Up In Court
26th August 2014 Susan Hoyle - Family Business Solutions
Leading family business consultants, Family Business Solutions, comment on a case in the High Court which left a family, and its business, in disarray.
The case vividly illustrated how different types of owners, lack of a governance structure and the desire to 'future proof' a business for generations to come, can cause problems down the line.
We’ve often written about the different types of owners in a family business, describing the custodian owner – “the family business is part of our heritage and we’ll pass it on to the next generation” and the value-out owner – “we’ll sell the business if it’s the best route to generating value for the family.”
We’ve also written on future proofing the family business through a formal governance structure so that when the family expands, the ownership model can adapt too. We’ve also written on Trusts and how, in some circumstances, they can be helpful.
A court case perfectly illustrates how the desire to future proof a business can leave the business, and its family, in disarray when the different types of owner disagree and where there are no governance structures like a family council or a family constitution in place.
In 1961, a Trust had been set up to run the family newspaper business by its founding owner. As it does, time had ticked on and the Trustees had received an offer for the company which they were minded to accept. The newspaper industry was in decline and the Trustees felt that the business should be sold before its value was compromised. The buyer wanted clear ownership of the business and would only buy if he could receive 51% of the shares in the company.
Then the Trustees hit a problem. There were now three branches to the family, each of whom benefited equally from the trust. Two branches of the family, the 'custodian' owners, were adamant – they did not want to sell, the third branch did. The Trustees went to the English High Court to ask for permission to sell anyway as they believed a sale would, in the longer term, be in the best interests of the family.
The Court disagreed and refused them permission to sell, deciding that the family could give direction to the Trustees about the future of the business.
What this case brought into sharp relief were the problems which can emerge when, with the best of intentions, a Trust is set up without considering the future. There is little doubt that establishing such a Trust during the settlor’s lifetime can have big advantages, not the least of which is the ability of the settlor to pass on his business to a succeeding generation. In this case, it was not actually the next generation who ended up benefitting from the Trust, but the third generation.
There are many reasons why a settlor might not want to allow his immediate successors to benefit directly. Often the age of the successor is a factor – the beneficiaries might not be old enough (or mature enough) to own shares in their own right. The settlor may prefer to select Trustees who he can trust to act as custodians for all future generations and not just the immediate successors. There may also be tax advantages in using a Trust.
Lesson No.1: Choosing trustees
One thing is certain, though, and the first lesson to be gleaned from this case is that one of the most important aspects of establishing a Trust is the selection of Trustees.
Agreeing to be a Trustee is no light matter. Firstly, all Trustees owe 'fiduciary' (i.e. good faith) duties to the beneficiaries, meaning they should always consider the beneficiaries’ best interests. A settlor must be sure the chosen Trustees can be relied on to perform those duties.
Secondly, Trustees have to ensure they are doing their best to preserve the value of assets put into the Trust. This is the case even if the Trust itself gives them discretion on whether to sell or keep assets.
In a family business Trust, this can be of vital importance especially where the settlor wants to direct his Trustees to retain their interest in the business for future generations of the family. If, as in the case under discussion, the business loses value or, on the other hand, if it gains in value and the Trustees want to capitalise on those gains, the Trustees can be held liable if they simply do nothing with the asset because of the specific instructions of the settlor. So the settlor has to appoint Trustees who will stick to his wishes but still know how to recognise when difficult decisions might have to be made.
Lesson No.2: What type of owner you are matters
Of course, if the family business had articulated its values and views to the Trustees, the court case might not have arisen, and this is the second lesson to be learned.
It was clear that there were two attitudes to ownership in the wider family - the custodian owners and the value-out owners. These differing attitudes caused a problem as, when entering into the Trust in 1961, the settlor did not direct which attitude to ownership the family should adopt. Compounding this was the lack of a stated mission for the business, or agreed vision and values, which left the business lacking direction and so led to the almost inevitable conflict.
Lesson No.3: Governance matters too, as does updating to reflect changed circumstances
Businesses, and families, grow over time and what suited fifty years ago may not be relevant today. When the Trust was established, both the business and the family had a much simpler structure. Increasing complexity in both, coupled with a lack of direction, vision and values led to the mismatch between Trustees and the family.
This is the third lesson to be learned – look out for the consequences of progress. As a business expands, it should consider putting in place a family charter or constitution, or forming a family assembly and family council so all sides of the family can be heard. Whatever body is chosen can then set an agreed direction with the Trustees.
In this case, the settlor simply put the business into the Trust and divided it between his three children, no doubt for the very best of intentions. He also seems to have selected his Trustees well. However, by failing to identify possible issues involving successor generations, failing to take into account issues which arise from complexity, and failing to put in place governance structures which would have helped all beneficiaries get the best out of the Trust, the settlor made it almost inevitable that difficulties would emerge many years later.
So what does this case mean for family businesses?
At its simplest it demonstrates that businesses and families change over time. If neither business nor family are prepared to manage change through setting up structures to govern family behaviour in relation to the business, like family councils and family constitutions, problems can arise.
If the family in this case had had suitable structures in place and a clearly articulated vision of the type of owner they wanted to be, perhaps the family dissent that led to the High Court might not have happened.
About the Author: Susan Hoyle is a family business specialist who works with family businesses and business families to ensure both the business and the family are, and remain, in good business health. Susan can be contacted through email@example.com