Whilst family business are governed by formal documents such as articles of association, the conduct of the business often relies on a concoction of ‘understandings’ and ‘agreements’ about how the business should operate.
These understandings can be quite informal and are often not documented especially in family owned businesses. However, in appropriate circumstances they will be enforced by the court and can have a major impact on the outcome of shareholder disputes.
It is an established principle of law in relation to what are known as “unfair prejudice” actions, that shareholders in a company may have “legitimate expectations” which supersede their strict rights under the articles of association.
- Typical examples of family business ‘expectations’ include:
- Shareholders will have a role in the strategic management of the business,
- Dividends will be paid regardless of an individual shareholder’s contribution to the business,
- Family shareholders will be entitled to a job within the company,
- Certain benefits, such as private healthcare, will be available to family shareholders.
Should a family business shareholder claim be bought to court, there are a number of factors that may limit the principle of expectations, for example;
- Understanding and expectations may not have automatically followed down through the generations within the business – A child or spouse of the founding shareholder may find that these expectations do not apply to them.
- The behaviour of a family business member can be closely reviewed. The weaker the claim for expectation is, the more likely it is that it will be possible to justify not meeting those expectations on commercial grounds or in light of that shareholders behaviour.
For example – an expectation by a family business member of employment within the company can be legitimately ignored if that individual lacks talent or if they have behaved badly.
A case study of Re Westshield Ltd demonstrates clearly how destructive financial disputes can be within a family business.
- Re Westshields Ltd was a classic family business. Set up by the first generation (parents), it grew into a successful organisation. The second generation of children included three boys and one girl, all of them worked within the business at one point or another, and each of them were gradually passed shares in the company.
- As is often the case, one of the children became dominant within the business and came to be seen as the natural leader / successor. Eventually this was formalised by the dominant sibling becoming managing director with a larger shareholding. Two of the others were directors and the last sibling retained a shareholding.
- The business hit financial hardship, a third party investor came in and the parents exited the business.
- Relations between the dominant and other siblings took a turn for the worse, with the dominate sibling dismissing the other two co-director siblings. Both sides demonstrated sibling rivalry rather than commercial acumen.
- No resolution could be found so a petition was issued by the three siblings against the dominate sibling (who now controlled the company ).
- On face value, the siblings had a good case as they were excluded from the business when they had legitimate expectations to be directly involved in the business.
- Despite attempts at mediation no resolution could be found.
- The Judge found that the dominant sibling had acted unfairly to his siblings, but to a much lesser degree than they had been claimed. In particular, he found that excluding the three siblings / co-directors was not unfair because of their behaviour.
- As to the remaining ‘unfair actions’ the Judge found that the other siblings had acquiesced at the time and could no longer complain.
- As a result, the Judge declined to make an order requiring the dominant sibling to acquire the shares of his siblings or indeed any order for resolution at all.
- So, unless they come to an agreement the siblings remain locked together in the family company having spent years of their lives, and lots of their money, on an ultimately fruitless legal battle.
The moral of this case study?
Litigation of family business disputes is a high risk strategy and should be seen as the last resort. If you do, however, find yourself in the middle of a family business dispute contact firstname.lastname@example.org who will help you to navigate an effective strategy for resolution for all parties concerned.
Understandings between family shareholders, even if not formally documented, are important and will be given weight by the court in unfair prejudice proceedings.
Furthermore cases of this nature are an example for all generations of shareholders to encourage the wider family to properly document such understandings in a shareholders agreement.
If you recognise the need to formally document the roles and responsibilities of family members in business – please contact email@example.com.
Alternatively, you can call the office on 01283 526200 to speak to either of them directly about the situation you find yourself in.