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A Family Affair: The Risks of Going Into Business With Your Family
Date: 24/11/2023 Type: Articles Topic: Private Client | Investment and HNWI’s |Viewers of Succession will be familiar with siblings squabbling over who succeeds Dad as the next CEO of the multi-billion family business empire. Yet behind the gloss of TV drama, similar scenarios play out in real businesses, as the stresses and challenges of running a business are magnified with the added dimension of personal and family relationships. Such businesses have the potential to be incredible successes but can equally degenerate into bitter inter-generational and/or sibling feuds. So how do family businesses navigate both the legal and personal landscape and make a success of their business? Reflecting on the statutory framework, recent case law and practical considerations, we consider how family boards can function effectively and sidestep the potential pitfalls.
Does everyone know their duties?
When going into business with family members or friends, or bringing them into an established business, it is easy to overlook the importance of corporate governance. Even where a business is run in an informal way, board members are subject to the same responsibilities as any other director and it is crucial for family members to understand their roles.
The starting point for directors of English companies is familiarity with the duties contained in sections 171 to 177 of the Companies Act 2006. Although each duty has its own particularities, there are commonalities for directors to be aware of.
Record-keeping is fundamental. Keeping a record of decisions and how they have been reached is not just good business sense; records can be a key defence where allegations are made as to the conduct of the board and factors that might have motivated decisions.
Understanding the business itself is also of paramount importance. Section 172 requires a director to promote the success of the company; to do so, directors need to understand what the company's stated objectives are (including by reference to any objects referenced in the Articles of Association).
Directors also need to be alive to changes in the commercial landscape, including ESG considerations. In ClientEarth's recent challenge to decisions made by the board of Shell (in ClientEarth v Shell Plc [2023] EWHC 1897 (Ch)), the Court rejected ClientEarth's argument that a number of "incidental" duties attached to the duties in sections 172 and 174. In doing so, the Court rejected the argument that the board had a specific duty to accord appropriate weight to climate risk and to adopt climate risk mitigation strategies. However, it is not impossible to consider a situation – particularly where a company has incorporated ESG considerations into its stated objectives – where a court might accept a duty exists to factor in ESG considerations.
All families bicker – but in a business context there needs to be a clear understanding as to what the company's stated objectives are. The less room for misunderstanding and interpretation the less family fighting there will be.
Whose money is it really?
In family businesses, particularly where directors may also be shareholders, directors must remember the distinction between company money and personal money.
A recent derivative claim to come before the High Court is a timely reminder of the potential for conflict. In Re Milestar Ltd [2023] EWHC 2153 (Ch), the claimant shareholder sought permission to continue a derivative claim regarding a company owned by three brothers and a sister, where a series of family disputes had resulted in a number of pieces of litigation. The present claim concerns allegations against two of the siblings, including for alleged abuse of the powers of the signatory to the company's bank account and allegations that company money has been improperly retained by one of the siblings in his personal capacity.
At this stage, the High Court was simply required to consider whether permission should be granted for the claimant to continue his derivative claim. In granting permission, the court deemed that the claims were not ones that no director acting in accordance with their duty to promote the success of the company would continue. Permission for the claim was granted up to exchange of witness statements, at which point further permission will be required.
Whilst this court decision is only a preliminary one, disputes around the use – and misuse – of company money are not uncommon i.e. employing family members through payroll and to have company credit cards/directors loans. Reviewing the authorised signatories on the company's accounts, introducing a requirement for multiple signatories above certain thresholds, and ensuring all directors are clear on what company money can – and cannot – be used for, can mitigate the risk of muddling personal and business resources or leading to misunderstandings between family members.
Is there a conflict?
In fulfilling their duties, company directors must be alive to the risk of a conflict of interest.
Once again, record-keeping is king: establishing a routine practice of considering and declaring conflicts of interest at the start of board meetings encourages directors to consider the potential for a conflict arising, and particularly so where the added dynamic of personal and family relationships heightens the risk of a conflict.
Every conflict must be considered within the context of its specific circumstances; that said, when in doubt declaring (and documenting) a potential conflict is likely to provide some protection to the director from allegations of partiality. Families may also want to introduce safeguards against the risk of a board deadlocked by conflicts of interest, for example by including an independent board member and considering a balance of board members between different sides of the family.
Deadlock provisions – what happens when it all goes wrong?
Just as no one wants to spend their wedding day anticipating a time at which the marriage might break down, very few family businesses wish to consider the possibility of a family feud on the day they sign the paperwork to welcome a new board member or shareholder.
Yet the reality is that many family businesses – including highly successful ones – can unravel in the face of disputes at director or shareholder level.
The recent High Court case of Ghenavat v Lyons [2023] EWHC 2428 (KB) exemplifies the perils of a deadlocked company, where deadlock can become a breeding ground for open hostility. In that case, two friends set up a property management and investment business. As the business grew, two other directors joined the business, including the first claimant's father. Over the course of several months, the relationship between the defendant and his co-directors (the claimants) suffered an acrimonious breakdown. Attempts to buy out the defendant's shares came to nothing and, with the defendant's consent required to allow the company to pay its creditors, the company ground to a halt. Against that backdrop, the defendant embarked on a campaign of harassment, with allegations thrown at the claimants, and repeated to friends, family and other third parties. Those allegations included that the claimants had diverted company money to the account of a new company, which will be a matter for separate Chancery proceedings to consider from a company law perspective.
Sometimes, deadlock is unavoidable. However, building provisions into the shareholders' agreement or Articles of Association to mitigate against the risk of deadlock at board and shareholder level can allow for a quicker and easier route to end a stalemate, allowing the business to move forward rather than flounder through a winding up process. This might include building in provisions for a particular member of the family to have the decisive vote in the event of deadlock. Trusted advisors outside of the family also have a key role, whether it is a formal one within the business or they are relied upon for an impartial voice to mediate between family members where hostility breaks out.
There is also the question of what happens if a key member of the family business – particularly the patriarch or matriarch – dies. Taking the time to understand the interplay between provisions in a will, the Shareholders' Agreement and the Articles of Association can help anticipate the potential risk of deadlock. Establishing a succession plan for the family business in advance, and thereby avoiding the turmoil associated with impromptu succession-planning, is likely to be beneficial to both the business itself and the dynamic between family members.
Is it worth it?
Going into business with family members and friends can be fraught with difficulties, particularly the risks of personal disagreements impacting the business and of company politics infecting close personal relationships. But keeping an eye on corporate governance, documenting the decision-making process and seeking to future-proof the corporate structure against deadlock can mitigate against those risks.
A successful family business can of course be hugely rewarding – and a truly life changing experience for many generations to follow. The rewards can be huge, particularly where the family can think creatively to find roles for different family members to play to their strengths. For those willing to accept the risks, there is great scope for success in bringing family members into the boardroom, without emulating the clashes within Waystar and Logan Roy's family.
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Victoria Pigott, Philippa Rees & Jenny Vipond - Mishcon de Reya
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