PLANNING FOR DISPUTE WHEN THINGS ARE GOING WELL
by Edward D. Tarlow, Esq.
There is always the risk of conflict in business. But when family is involved the risk of dispute is even greater. Family business disputes generally center around governance, business management, ownership and succession (transition) and can be exacerbated by the personal dynamics and history among family members. The business may be profitable and running smoothly today, but under the surface, conflict lurks.
Generally a dispute is preceded by a triggering event, like the death of a founder or a change in circumstances of a family member or the business, and will erupt when the family, the business or both have a history of poor communication and have not planned for conflict. How family members handle the tensions between family and business and whether they have anticipated conflict and armed themselves with tools to deal with a dispute can determine the extent of the ultimate damage. Anticipating and planning for a potential dispute when the goals and objectives of the business and the family are aligned combined with good communication between and among the business and the family is the best way to avoid potentially damaging conflict when a triggering event occurs.
Governance. Good family governance, good business governance, and good family business governance are illusive concepts with many facets. Best practices of business governance recommend the establishment of a Board of Directors with as many independent qualifying directors as a controlling ownership will permit, or alternatively, a qualified Board of Advisors to handle specific strategic issues of the business. Best practices for family governance recommend regular family meetings to discuss issues that affect the family.
The intersection of these two governing systems, business governance and family governance, is family business governance. Best practices of family business governance recommend the creation of a formal family council to discuss issues that affect the business as well as the family, such as employment of family members, salaries, distributions, ownership and succession. This structure will allow the business to identify and address the concerns of the family and the family to become aware of the concerns of the business and recognize and deal with its challenges.
It is at this intersection of family and business where the possibility for a dispute is greatest. It is also at this intersection where the business and the family have the best chance of aligning their interests to avoid future conflict.
Business Management. There is no more volatile business management issue than the allocation of capital. Family members in control of the business make decisions regarding the running of the business, including the allocation or reinvestment of capital and payment of executive compensation and fringe benefits, all of which affect the risk associated with running the business and the monies available for distribution to active and inactive family members.
When there are family members both inside the business (with the benefits of employment and control), and outside the business (with none of the benefits of employment and control), there is the greatest potential for a dispute. Good communication between active and inactive family members and between the family and the business can help avoid a dispute.
Ownership and Succession. Founders stock often passes down the line of lineal descendants without much thought about whether those descendants have the interest or the aptitude to successfully operate the business. This lack of thought is part of the reason why so few family businesses survive to the 5th, 4th, or even 3d generation. This lack of thought also plants the seed for explosive family conflict.
Planning ahead for the succession of the business is paramount for the success of the business and the family. When planning for transfer of the business to a younger generation, it is often beneficial to hire independent advisors to counsel the family regarding the impact of succession decisions. Experienced lawyers, accountants and thoughtful family advisors can play an important role in this process. There is never a perfect solution to complicated succession issues, but an attempt to thread the needle in a way that is fair can often avoid a future dispute.
Shareholder’s Agreements can also reduce the potential for dispute by addressing the disposition of an owner’s interest on death, including restricting transfers of business interests among and outside the family. A Shareholder’s Agreement can also delineate the rights of the president, treasurer, and other officers, dictate the composition of Board of Directors, deal with family employment issues and provide for resolution of conflict in a non-public setting.
Private resolution of conflict becomes more important in the family business setting because, when a dispute erupts and becomes public, vendors, employees, bankers, customers, friends and associates become aware of the conflict which can dramatically affect the reputation of the business and of individual family members. Having a well drafted Shareholder’s Agreement can prevent bad publicity and provide tools for a successful resolution of an ownership or succession dispute.
By keeping the lines of communication open and understanding that there is always the potential for dispute, family business owners can arm themselves with tools they need to avoid and address future conflicts.
Edward D. Tarlow is a founder and the President of the Family Business Association and is a founding member and President of the law firm of Tarlow, Breed, Hart, and Rodgers, PC. To read Attorney Tarlow's bio, click here.
