A version of the following article was published in CA Magazine.
Some family companies are tightly run with an agreed or tacit understanding of who gets to take what out of the business.
This includes managing the expectations of shareholders removed from the day-to-day running of the business who may have unrealistic expectations, or lack information, on which to make proper judgements.
In a properly structured family business, the contribution made by those working in it, be it family or non-family members, sits apart from any return to be paid to shareholders.
In all of this, the board has to proceed carefully and balance the interests of all stakeholders.
Those duties have now been codified in the Companies Act 2006.
Directors have always been required to act in good faith in the interests of the company and must act in a way most likely to promote the success of the company for the benefit of its members as a whole.
They are also required to exercise independent judgement, and this is where tensions can arise.
The working directors may feel they should be paid more, though if this were to be via a dividend then in the absence of different share classes and dividend rights, dividends would benefit all holders regardless of their contribution.
In extreme circumstances resentment can arise: those working in the business may feel they are carrying passengers while those outwith the business may think management are feathering their nests.
The 30-year war….a family scrap gone wrong
An extreme example of this is a 30-year family feud which came before the English courts in 2017.
An established family scrap metal business in England had grown to be a European market leader and by its third generation had a shareholding base spread across a diverse family group.
Substantial dividends had been paid until 1985, but in 1987 the chairman confirmed no dividends would be paid in future as a matter of policy.
Between 2007 and 2015 the annual average salary for directors rose to £1.57 million while the directors and their wives also received luxury cars and use of a company yacht.
Three “non-executive” shareholders, holding more than 25% of the company's shares, sued for unfair prejudice, challenging the conduct of the Board in favouring the majority shareholders.
The claimants argued the ‘no dividend’ policy denied them a share in profits - which also devalued the claimants' shares - and was being used as a mechanism to force a sale of their shares at less than their true value.
So, was the no dividend policy fair, and was the remuneration excessive? The two points were linked.
The court took the view, where there were profits available for distribution, then even if - as claimed in defence - there was a process for discussing dividends, the policy statement meant there was only going to be one conclusion, namely not to declare a dividend. The board had effectively closed off profit share to members who were not also directors.
In addition, the remuneration levels were unjustified given the responsibilities and duties carried out. This far exceeded any amount fairly reflective of the work done by the directors.
The usual remedy for unfair prejudice is an order for the claimants' shares to be bought back at a fair value.
Having established the remuneration was excessive, the excess would require to be added back, thus increasing annual profits.
Chartered accountants would not be surprised at this approach in fixing a fair figure for the maintainable earnings for the company on which the valuation should be based for buy-out purposes.
So what are the lessons?
Dealing with genuine conflict is never easy between branches of families with shares in what was once a tightly held company. Blatant, inappropriate behaviour or policies will fuel the fires.
Here, the frank discussions had perhaps been too frank.
Some companies recognise, and have members who accept, the distinction between working and non-working shareholders, No one size fits all, because the dynamics of family companies are as different as the families themselves.
A shareholders agreement with agreed principles aligning family values with corporate discipline is highly desirable.
Early intervention and a facilitated approach to heading off conflict across the family shareholder group is always better than expensive and emotionally charged litigation, but if all else fails, a remedy does exist.