In most cases, your company’s directors, officers and controlling shareholders are breaching their fiduciary duties by approving non-business related expenditures. These people are bound by two primary fiduciary duties. First, the fiduciary duty of care requires that good, reasonable decisions be made through the exercise of rational business judgment. Second, the fiduciary duty of loyalty requires that decisions be made in the best interests of the entity rather than for self-interest or any other reason.
Smart planning—at minimal cost and effort—to declare exceptions can position a family business for continued financial success without sacrificing family values. In so doing, directors, officers and controlling owners will be shielded from breach of fiduciary duty claims when disgruntled family members attempt to create legal trouble. All of our clients greatly value proactive measures designed to preclude years of litigation and the related stress, legal fees and persistent disruption. And when these measures are couched as a way to promote family unity and family values, everyone is a winner.
Unfortunately, simple, straightforward tools to foreclose these potential problems are commonly forgotten during elemental planning. Likewise, attorneys know that every time a person signs his or her name to an agreement, it is an opportunity to reinforce rules and values. It is important to note that your legal counsel possess knowledge of the state’s substantive and procedural rules that govern your particular situation.
The following bullet points provide simple ways to ensure directors, officers and shareholders are authorized to promote both the business and family values:
• Statements In Organizational Documents. Straightforward waivers and exculpatory provisions can specifically provide that certain non-economic factors such as family continuity or hiring from particular pools (e.g., a particular type of charity) are priorities that must be considered and may even override the duty to maximize profit. For example, organizational documents filed with a state can expressly declare that a company’s purpose is “to engage in any lawful activity and to make charitable contributions with at least fifty percent of the company’s net profits.” Likewise, founding documents could state “the mission of this company is not entirely compatible with—and may even contradict—the maximization of profits or shareholder value to promote continued family ownership and charitable purposes.”
Courts have consistently approved corporate by-laws that are intended to preserve family control over a business. A commonly used example is a mandatory right of first refusal to purchase a company’s shares. (Stroud v. Grace, 606 A.2d 75 (1992)(Delaware law); Clayton v. James B. Clow & Sons, Inc., 327 F.2d 382 (7th Cir. 1964)(Illinois law)
• Integration Of Key Documents. All that is needed is a written statement—in the trust, by-laws or a stand-alone document—noting which legal document governs posthumous decision making. Failure to perform this task is inexcusable.
Without a directive, when a company’s stock “pours over” into a trust for the benefit of the younger family members, then both trust law and corporate law govern the situation. Because the trustee technically now owns the stock, the trustee is faced with serious questions. For example: should I immediately sell the company to pay for the beneficiaries’ inheritances or continue operating the company to benefit family members on the payroll?
Each state has its own rules. For example, in Virginia, a pour over will called for distribution of the decedent’s ownership shares versus a shareholder agreement that called for a mandatory purchase of the decedent’s shares. After years of litigation, the Virginia Supreme Court ruled under that case’s specific facts that the shareholder agreement took priority. Jimenez v. Corr, 288 Va. 395 (2014)