Legal safeguards and mechanisms are not always front of mind for families when establishing and running businesses and, in most cases, the importance of a well-documented legal relationship is not fully appreciated until a critical event occurs or a dispute arises.
The issue of documentation is particularly relevant in situations where family businesses propose to create legal relationships between themselves as part of a wider passing of control and ownership to the next generation. Best practice is to have an appropriate governance framework in place from the outset.
There are a range of legal documents which family businesses can implement as part of their governance framework, and the practical advantages of doing so are that it provides a clear indication that the parties intended to enter into a legal relationship and evidence the terms of the family’s personal and business objectives.
Rather than operating as standalone documents, all documentation used for discrete family businesses should acknowledge each other and be consistent, with commonly tailored provisions to meet the family’s needs. A tailored governance framework can significantly reduce costs and commercial disruption, particularly where a succession plan is playing out or an internal dispute arises.
The following are some examples of the types of agreements and constituent documents that are commonly found in the governance framework of a family business:
- Family constitutions (also known as family agreements or charters) are unifying documents that help operative and non-operative family members understand the goals, expectations and code of the family business. This exercise can reduce the risk of disputes in a business succession context by fostering engagement.
- Company constitutions are contractual arrangements between the directors and the members of a company and allow the company to impose additional obligations on directors and members (in additions or substitution to the replaceable rules set by the Corporations Act 2001 (Cth)). Setting clear rules and boundaries in constitutions can be significant for ensuring a family business runs as envisioned. Where the family company is also the trustee of a family trust, the constitution should also outline the family trust’s distribution and company dividend policy.
- Shareholders’ agreements (or unitholders’ agreement for a family business operating through a unit trust) essentially act as insurance policies for the underlying owners of the business - they are agreed during the good times to deal with bad times. They govern matters such as decision-making provisions, entry and exit of shareholders, insurable and non-insurable trigger events, valuation methodology and internal dispute resolution processes.
- Buy sell deeds provide the necessary option mechanisms to facilitate insurance funded business succession in the event of a critical event (e.g. death, trauma or disablement).
- Trust deeds regulate the relationship between those in control of a trust (i.e. the trustees) and the intended beneficiaries. The trustee of a family trust can only exercise powers as they exist under trust law or as conferred by the relevant trust deed, so regularly reviewing the deed is critical (particularly when undertaking new activities on behalf of the trust). In terms of trust succession, the role of an appointor is an important control mechanism over the trustee (as they are traditionally given the power to add and remove trustees). While it may be intended that a particular family member assumes this role in the event of an existing appointor’s death or incapacity, the terms of the deed might express a contrary appointment. In this case, it may be necessary to amend or hardwire the terms of the trust deed to align with the family’s needs (although specialist advice should be sought, as some trust deed variations give rise to unintended consequences).
- Partnership agreements can assist in evidencing the family members’ intention to form a partnership and be legally bound to each other. Subject to appropriate drafting, a partnership agreement can also provide advantages in specific legal or commercial contexts (e.g. taxation) and, at the very least, may operate to reduce the duration and cost of a dispute by clearly setting out the arrangement.
As with all matters involving family business affairs and successful governance frameworks, care must be taken in drafting the terms of all agreements/constituent documents and appropriate legal advice should be sought to ensure that suitable mechanisms are considered.
