Rushing towards a constitutional meltdown

Trying to set up a family constitution when everything goes to hell can be a huge mistake. Unless it's a thoroughly considered and reviewed document it can cause more problems than it solves.

In some families one or two members will start putting together a constitution when tensions flare up. That never works. A good constitution, the governance plan for the family business providing a link between family matters and the business, can take years to develop and there are many threshold issues like enforceability and flexibility.

Anyone trying to get one done quickly to ease a conflict will have to think again.

Adelaide lawyer Rosey Batt says creating a constitution can take “anywhere from a short period to a number of years.” And creating one to ease tensions is no solution. The process, she says, is long and involved. Smart companies do it before they are faced with issues.

Ideally, she says family constitutions should be set up by the first generation. But the document has to be flexible enough to be changed with children growing up, marrying and having kids.

Batt talks of one case she had where a family business set up 70 years ago had a constitution that stipulated shares would only go to the male lineage. The owners had acted with the best of intentions and had the best legal advice – at the time.

Batt says constitutions need to be constantly reviewed to avoid this sort of problem.

“There needs to be a review process to accommodate the changes that happen in law and societal expectations,” she says.

“If you think about a constitution in a company or not for profit, I always say it’s an ongoing process. So you would want to see something on the agenda every year that you are just checking whether the constitution needs to be reviewed. I don’t think it would be any different for a family constitution, you would hope there is an annual meeting where consideration is given to it, whether it’s five minutes or five hours. If you are looking at it every year you would keep on top of it.”

An alternative might be to put amendment mechanisms into the constitution where, for example, a 75 per cent vote could change some of the rules.

The problem is family constitutions do not necessarily have the same legal weight as company constitutions. So how can they be enforced? Lawyers say it really comes down to whether the family turns the constitution into a contract. And how many families would want to do that?

Batt says doing that means everyone would have to get legal advice about where they stood in the business.

“If you want it to be totally legally enforceable, there needs to be a lot of consultation and a lot of independent advice,” Batt says.

She says creating a constitution will force people to ask hard questions about the business. It could throw up issues. They might decide to sell it, because it’s not profitable enough, or maybe people aren’t committed enough to it.

And while a KPMG/Family Business Australia survey has found that four out of five family businesses don’t have a constitution, Batt says it’s a model that only adds value to the business.

Paul Lucas, a partner at Parramatta law firm Coleman & Greig says a family constitution is not there to head off conflict.

“It’s a document which can be used to help build a family culture and help understand what’s expected of them, what’s expected of other family members and what’s expected of the company,” Lucas says.

A family constitution sets out the values and principles behind the business. It could also define the strategic objectives that reflect the agreed family values and sets out the way the family makes decisions regarding ownership and management. It could detail the rules for hiring, firing and remunerating family members working for the business. As well as the rules for appointing people to the family company’s board of directors or council, the rules of conduct for the family council and disclosure policies for family members not working in the business. The rights and obligations of shareholders in the family business can be covered too, along with rules for buying out shareholders, policies regarding external or non-family members owning shares or managing the business, succession policy, nominating, monitoring and training managers and procedures for amendments to the constitution. The family constitution works like a delegation of authority in a normal company.

Darren Somers, a partner at Meerkin & Apel, says that family constitutions could help avoid, or at least manage, litigation. Family business litigation is nastier and more emotionally draining than family law cases where the couple often decide not to go to court because of the kids. Bob Jane’s $2.9 million lawsuit against his son Rodney, and the battle over Gina Rinehart’s trust arrangements are cases in point.

“If you have a family that often can’t agree and you have some strong personalities in there and some control freaks and others who are more passive and get really angry at the control freaks and then they explode and everything goes to hell, then they are useful documents,” Somers says.

“The family constitution can help alleviate those sorts of disputes because you put in place rules and agree to principles. It’s not necessarily a legally enforceable document but it might help stop people going to court.”

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