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Guy Broadfield, Senior Associate, Burges Salmon

Hello and welcome to season two of Death And Taxes, a weekly podcast by the Private Client team at Burges Salmon. My name is Guy Broadfield and I am a tax and trust lawyer in the Private Client team. In this special episode of Death And Taxes we have partnered with The Institute For Family business to discuss succession planning for family businesses. In part one of this two-part mini-series, Richard Handel and I discussed the impact of divorce on family businesses. In this second part I'm joined by Caroline Emslie, a senior associate in the firm's Disputes team to discuss the impact disputes can have on a family business. Caroline advises on a broad range of contentious matters, with an emphasis on disputes relating to trusts, wills and tax planning, in particular, in family businesses.

 

The Institute For Family Business known as the IFB, is a dedicated and independent membership organisation, whose aim is to champion and support family businesses. It is the largest family business organisation in the UK, and has a wide range of family businesses as members across the country. We discussed the IFB in more detail in part one of this mini-series, so to find out more about the IFB please listen to that episode or see the IFB website ifb.org.uk.

 

So Caroline what we've spoken about with Richard is the impact of quite a specific event on a family, of course on the individual in question and then the wider family members and some business families may be impacted by divorce, some may not. Of course many hope that they won't but it sometimes does happen, but I think when it comes to the points I've just discussed with you, it's important to note that you know some business families may not be impacted by divorce but that doesn't mean there is not a risk of dispute, as between the family members that might impact the business at some point, and indeed some of the characteristics of family businesses do lend themselves to the possibility of at least minor disagreement in some cases and more fundamental dispute as well, so is it worth just explaining your thoughts on that in first instance?

Caroline Emslie, Senior Associate, Burges Salmon

Sure. Yeah I agree I think in order to give a family business the best chance of being passed on, it's really fundamentally important to try to insulate that business against disputes, and that's where they're during the lifetime of the business, or on the transfer of power. Family businesses are liable to face the same issues and the same disputes as other trading businesses, you know supply and contract disputes, employment disputes - all of those types of issues. But the family relationships which underpin family businesses mean that they can be open to family business specific risks and potential disputes as you mentioned. Disputes between family members can happen anytime, but the importance for succession is that they have the potential to really disrupt the proper running of the business - they can cause financial uncertainty and then impact on business management, and if there's uncertainty it's going to be much more difficult for businesses to take opportunities as they arise, to invest in growth and also to facilitate the business being passed on in the way that the owners might have hoped or anticipated.

 

And I think on that point, the fundamental points that I would kind of flag for family businesses and business owners to focus on are making sure that the rights and obligations of the business owners and the other family members are clearly understood and clearly documented, and also making sure that they've planned in advance for contingencies including a loss of capacity or death. And particularly in relation to the transfer of control, it's really important to just make sure that as far as possible whilst those conversations can be quite difficult, to make sure that all of the family members appreciate what the plan is, and I think it's normal for family members involved in a family business to have their own expectations and hopes for what will happen next and what their part in that will be and to try to make sure that there are no surprises as things kind of play out because that's certainly a fertile breeding ground for disputes.

Guy

Yeah because there are elements to which you know discussions happen between family members either around the dinner table or otherwise, and sometimes they're talking to each other as siblings, or you know as parents and children, without really thinking of themselves as shareholders in a business. That can only lead to certain expectations on one side or the other which do need to be managed, to avoid the risk of any future disagreement to the extent one party doesn't necessarily get what they expect, or are not treated in the way that they would hope.

Caroline

Yeah and I think that that leads into an interesting issue which arises in the context of family businesses run via limited companies, and a point around unfair prejudice petitions where people had expectations as to how the business was going to be run that perhaps arose or they feel that they have an entitlement which perhaps it's not their clearly documented rights as a shareholder, but it's something that is a right which has arisen as a result of agreements or understandings between them and their family members, which are perhaps not clearly documented.

Guy

And so this is typical when we talk about unfair prejudice this is about saying okay we've got a family business, the family shareholders are say you've got you know five family shareholders, you may have one family shareholder who's a minority shareholder on their own, they may own 20% of the company and by virtue of the running of that company either by the other four shareholders or the directors, that minority shareholder feels that they have been unfairly prejudiced and there's a claim that they can bring that allows them to, if it's what happens if that unfair prejudice is established what does it what does that mean?

Caroline

Well, unfair prejudice petitions can be brought by any shareholder of a company or group of shareholders, and to succeed those shareholders need to plead and prove a complaint that the affairs of the company have been conducted in a way as you said that harms their interest as a shareholder, and the normal outcome if somebody is successful in an unfair prejudice petition and I am saying this is the norm, not what the court is bound to do there's quite a lot of options for the courts, but the norm is that the majority shareholders will be required to purchase the shares of the minority shareholder, and often at full value so without a minority shareholder discount, and that can lead again to further issues and questions around the valuation of those shares, as we mentioned earlier there are often multiple ways to value shares and that can be kind of a broader dispute which involves looking really carefully at the business.

 

And so this is, I think the kind of takeaway from this is, it's kind of helpful example of how taking steps to make sure that things are really documented and included within you know if you want to give all of the siblings for example, if you want to give all of the siblings a right to participate in the management of the company, then the best way to do that is to make sure that that right is documented in the shareholder agreement, and if you want to exclude a right to participate in management again you could do that in a shareholders agreement and you can agree that the individuals have documented all of the rights and obligations that are owed to them and there's nothing else which is perhaps an equitable right which has been agreed separately or which isn't documented and is less formal.

 

I think it's just a good example of why documenting things, and making sure that things aren't done informally which isn't always the case in family businesses, but it's just sometimes it can be more likely that there will be informal agreements or understandings which sit behind things, just because of the nature of the family relationships underpinning the business.

Guy

Yeah and ultimately any sort of unfair prejudice petition would be destabilizing for the business, which causes a liquidity issue for the majority shareholders if they're required to buy out the minority shareholder, it would drive a coach of horses through any succession plans that there are.

 

So to avoid that to take away points are make sure your plans for succession are communicated clearly to all family members, and then documented correctly, and that as between you know the family members they should as far as they can look to act in accordance with their rights and obligations, in the documents.

Caroline

Yep I think that's right.

Guy

And so largely what we've spoken about so far has been on disputes during the lifetime of family members but I suppose quickly we need to cover off the important topic which we could probably cover in a completely separate episode about the types of disputes that can arise on the death of a family member particularly with regards to wills and perhaps unexpected provisioning wills for some family members.

Caroline

Yes I think it's often seen as a key feature of wills in England and Wales that testators can broadly speak and do what they want with their assets, but that absolute testamentary freedom is hemmed in by other rules and there are claims that can impact on it. So for example claims for reasonable financial provision under the inheritance act by individuals who don't consider that reasonable financial provision has been made for them under somebody's will, or perhaps estoppel or constructive trust claims whereby somebody feels that a promise or assurance has been made to them regarding what they're going to receive, they then rely on that assurance and they suffer detriment as a result of that assurance not having been honoured. And I think it's those types of issues it's hard to undersell the trouble which can be caused by a claim which attacks a will and changes the distribution of an estate.

Guy

Linked to that is to the extent that family members are surprised about the provisions in a will, or it may not give effect to what they hoped is the question of possible challenge to the terms of that will and in the capacity of the person who wrote it. And there are various ways to challenge a will that we see.

Caroline

here are, and I think capacity issues and challenges to the validity of wills are frequent and in order to try to address or cover off those types of planes it's really important that wills are thought of up front and well in advance, so not left to the eleventh hour where people are kind of rushing around trying to make a will because somebody is concerned about their health, it's those situations in particular where capacity issues can also arise. It's thinking about it well in advance so there's enough time to really think about how the business is going to be dealt with and passed on and to make sure that the will joins up with that, and that if there are any potential capacity issues there's time to take medical advice and get reports, which confirm the capacity of the individual making the will and again it's about addressing those issues up front and you mentioned surprises, I think in terms of all of those potential claims against the estates or against the validity of wills, it's about addressing things upfront.

 

So the will itself and any potential capacity issues and also the expectations of family members and those conversations can be really, really difficult to have, but are so important because whilst they might be difficult for the person considering how to structure their affairs, they can be even more difficult and potentially really damaging for the family as a whole, if following the death of that patriarch, matriarch, or family member then there is a subsequent family dispute, which can result in a really long-term conflict between family members so if there's anything that can be done to try to address that in advance and make sure that people's expectations are managed, then that can be really, really valuable.

Guy

Certainly when it comes to the older generation you know those family members may consider using trusts as part of their succession planning, whereby for example they may decide to transfer their shares in the family business to a family trust, either one created during their lifetime, or one that's created on their death under the terms of their will, whereby nominated trustees hold the shares for the benefit of the family members in question.

 

Now that's clearly a very different dynamic to the situation where the different family members hold their shares individually, and you know typically you might find that in that scenario the trustees of the family trust hold all of the shares in a family business, for the benefit of the family members. And there are any reasons, tax and otherwise, for following that route. In one case it might reduce the possibility of an argument as between family members at least at shareholder level because there is or it can be, a single shareholder holding all the shares and that allows for a sort of continuity of a single shareholder voice, which might make matters easier for the directors and allow them to carry on with the business on a commercial level, but of course it's not always a given that the family members and perhaps the younger generation agree with the trust type structure whereby it is the trustees and not the beneficiaries who are making decisions in their capacity as shareholders of the business.

 

And that can lead to dissatisfaction or disagreement, if beneficiaries, the family members in question, don't agree with the decisions the trustees are taking and of course I mean when it comes to family trusts and family businesses it is very fact specific, so you know depends on the terms of the trust, depends who the beneficiaries are, but most importantly it depends who the trustees are it's important for anyone who's considering going down that route to think about their choice of trustees because that's crucial, and importantly how they will engage with the family members/the beneficiaries going forward.

 

Whether family members are trustees or not is a matter of discussion, but the engagement between the trustees and the family is critical to ensure that the family members don't feel detached from the business, and feel that they still have an interest in the business over the long term.

 

So broadly Caroline, whether or not a family decides to use a trust to hold family shares, or individual members are going to hold those shares going forward, in either case the importance of succession planning can't be underestimated.

 

In the first instance it's crucial to have a plan that is communicated to all of the family members so that everyone knows where they stand, and that plan has to consider, or take account of, possible future risks like divorce on the basis that everyone hopes that that doesn't happen, but has to realize that there is a possibility, and tied in with that plan you can take steps to try and protect the business against those risks, so prenups and post-nups, such as the ones Richard mentioned. But then also once that plan has been agreed, it does need to adapt and be able to change in the circumstances, and so it's something that has to be continuously monitored and implemented, and that does require quite a lot of input from the family members.

Caroline

Yes, one of the big issues which often leads to disputes is surprises, and as you were saying as a family business grows or changes over time expectations are likely to change, and discussions will be had as to how things might be passed on and if documents and plans aren't more formally updated, then it can lead to a risk that that on the transfer of power people are surprised as to what ends up happening because actually their expectations from discussions with family members aren't reflected in the documents that haven't been updated for some years, the documents perhaps aren't really fit for purpose based on what the family business looks like now, and it's just keeping on top of that to make sure that there's no nasty surprises for anyone.

Guy

And particularly also if over the course of that time the family business has been successful and has grown in value, the plan that was agreed or at least talked about 15 years ago may not reflect what is needed right now.

Caroline

Absolutely.

Guy

There's more value to argue about which can lead to a greater chance of disputes so, something that has to be kept under close review and that's whether you're an individual family member or a trustee of a family trust who holds shares in a family business.

 

Thanks again for listening to Death and Taxes, a Private Client podcast from Burges Salmon. You can find out more about Burges Salmon and our team at Burges-Salmon.com, or on our Linkedin page. On next week's episode, we will be discussing philanthropy and how individuals can look to benefit the causes close to them. So don't forget to subscribe to listen to all episodes from season one and two.

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