17/03/2021

17/03/2021

Family Constitution- Its What, Why And How

As family businesses grow, so do the complexities associated with it. As these businesses evolve and new generations/stakeholders emerge it can result in the loss of a healthy communication and decision-making environment. This exposes the business to both internal and external risks. With this in mind, many families are resolving to record the vision and principles guiding their businesses in a formal family agreement i.e., family constitution that guides them towards a unified goal. What is a Family Constitution and Why do we need it? A Family constitution is a written document that records the core values and long-term goals of the family and their business. It essentially provides a framework for engagement of family members in the business decision making process by setting out the policies, procedures, or principles in areas like communication, use of family offices, investment expenditures, employment and many more. To list a few benefits of having a family constitution in place:
  1. Helps avoid role conflicts by addressing Who is responsible for What.
  2. Provides a process to resolve conflicts among family members through appropriate mechanisms or governance forums as may be set out in the document.
  3. Takes into account the family dynamics and relationship of family members with the business, unlike shareholder agreements which focus on legal right/obligations in relation to business.
  4. Acts as key tool to address transitional issues or deal with any unforeseeable event.
  5. Helps preserve confidentiality and promote cooperation among members of the family business.
Essential elements of Family Constitution The contents and length of a Family Constitution may vary from family to family but is essentially guided by the issues organically identified through family dialogue and engagement in the process. Ideally, a family constitution should consider inclusion of the following details-
  1. Mission and Values: Definition should be given to the key values imbibed in the family and the business along with the direction the business has chosen to achieve its key milestones and objectives – these matters should be kept under review and changes, with agreement, as circumstances change.  This statement would also record the different personal objectives of the family members as to income and wealth generated by the business, in particular retirement and cashing-out individual shareholdings. The Mission of the business will only succeed if the family members objectives are reconciled and aligned.
 
  1. Legal Status: Consideration should be given to aspects that have legal consequences and might require a legally enforceable agreement to recognise the same. It must be kept in mind that albeit a family constitution is legally non-binding, it is a legally significant document, which courts might refer to interpret the actions or decisions taken.
 
  1. Family Governance Structure and decision making: For effective decision making and management of family wealth, a clear governance structure must be provided for. This may include-
  1. Defining the role of different family members and key individuals.
  2. How different boards/committee should be structured and their purpose? For example a Family Council to have ultimate oversight on policies or strategies affecting the family and the business relationship or a Family Assembly to act as forum to discuss matters concerning same.
  3. Composition of such committees i.e. Who are the executive members, standing members, family line representatives etc. and the allocation of voting rights among them?
 
  1. Distribution of benefits: Policies stating how various benefits of employment, personal consumption, education, medical, housing etc. are distributed among the family members, should also be incorporated within the document.
 
  1. Plan for mentoring: Provisions or criteria for mentoring of young members of the family business i.e., age contingency or qualifying criteria of mentors and mentees, should be considered.
 
  1. Information disclosure and sharing: How information or reports pertaining to management, investment or use of family wealth, are disseminated among the family members. What information should/should not be disclosed. When should such information be shared. Events when access to such information must cease – all these aspects should be addressed.
 
  1. Disposal and transfer of interests: What requirements should be met for transfer or disposal of family business interest. Events when such transfers be permitted. Should there be a voting by family council/family assembly to give effect to such transfers? Nuances for transfer of interests through succession -  these should all be dealt with.
 
  1.  Plan B for unexpected: Contingency plans should be included to avert any damages from unexpected events like matrimonial disputes, deaths etc and consider how would the governance structure be altered in such eventualities. What is the role of Family Council/Family Assembly in managing transitions during such times? If any, what role should an external adviser play in this?
 
  1. Dispute resolution mechanism and penalties: A clear dispute resolution process (both formal and informal) should be laid down. Provisions should be incorporated for the process of the alternative dispute resolution to be followed, qualification criteria of mediators, penalties upon determination of any breach of conduct, etc.
Signatories and parties: Although the family constitution should be signed and ratified by all the adult family members and executives of the business, provisions in relation to qualification criteria i.e. age, work experience and position held in family business, should also be included for other relevant family members to become a party to the same.