Trustee Knowledge Series: Second Mastery Paper: Family Governance – Trusts

WHAT IS FAMILY GOVERNANCE?

“Family governance” is a term that describes a system in which a family makes decisions together to manage their wealth and businesses. Often the family will have a board of directors and a family council working in conjunction with third party professionals brought on board for their particular skills, but each system is tailored to each family’s situation.

The purpose of governance is to bring a multi-generational family together to develop family unity, strategy, communication, trust, and legacy. Often the family will be assisted by a family constitution that reflects family values, an ownership structure, and the employment of family members and non-family professionals in the businesses or family office.

WHY IS IT IMPORTANT?

Family governance tries to avoid the effects of the so-called “three generation rule” (ie the family patrimony is built up by the first generation and exhausted by the end of the third generation). This rule is reflected in many popular cultures; for example, in Latin America it is known as “Father-merchant, son-gentleman, grandson-beggar” while in North America a common phrase is “From shirt sleeves to shirt sleeves in three generations. But why does this happen?

As a family grows in wealth and numbers, the multigenerational view of the family’s continuity plan erodes because one or more factors come into play; below are some examples:

  • Conflict – a family can be crippled by conflicting views between generations or branches of the extended family, resulting in “turf wars”, meaning the family business suffers and may ultimately fail.

  • Inability to let go – the family patriarch is often the most content with the status quo of family businesses and as such is often the last to understand the importance of creating the governance that will take responsibility for the family business and the wealth in their absence. As a result, children and grandchildren do not have the same skills and ambitions to preserve and enhance the family heritage.

  • Culture – a significant wealth challenge to multi-generational families is a culture of entitlement (i.e. an unsustainable attitude of buying anything at any time without thinking about the impact or liability ) leading to capital erosion.

  • Wealth dilution – a culture of entitlement and conflict can lead to capital distributions and the breakup of businesses, leaving a lack of capital for investment purposes. Typically, a lack of capital limits access to greater investment opportunities, which means the inability to replenish lost capital.

A concrete example of a change in family attitude was the following: the American family had a successful one-product business generating all of its wealth, but the family was not proactive in promoting the growth of the business through new products or otherwise. Eventually, the family patriarch had an “awakening” and realized that without new products, wealth would dwindle. He therefore presented the family with a choice at a retirement: either invest in growth and increase the profit-generating capacity of the business, or invest in the fees of a psychologist through a program of Family assistance aimed at helping family members adjust to their new, less well-off, lives. The family chose to expand the business; new product lines have been successfully produced and the family continues to benefit.

Therefore, family governance is designed to provide the best chance that family wealth will endure beyond three generations.

KEY ELEMENTS

Probably the biggest problem facing families is the conflict between them. Therefore, good family governance will allow the family to avoid internal conflicts and the costly litigation that results. While each family is unique as governance required (which will arise from their culture, commonalities and differences), there are two common elements for governance as follows:

Family Constitution – This will contain important aspects of the family governance system and detail a range of issues, including the formation and operation of a family council. Essentially, the family constitution will document the operational mechanisms of family functioning and interaction and will likely cover the following:

  • family history

  • Subsidiary representation

  • Core Family Values

  • Labor conditions

  • Right to vote

  • Restrictions on Family Assets Transferred or Sold

  • family council

  • Use of family assets (planes or real estate)

  • Age of majority for children

  • Family education or investment fund

  • Position of spouses

  • Conflict resolution

  • Penalties

  • Amendment

Typically, these constitutions do not have the force of law and are not enforceable, but it makes sense for constitutions to be binding.

Family Council – With the participation of the extended family, a council is created to support the continued benefit of the extended family. It will consist of a small select group of family members to act on behalf of the extended family. The council will generally be given some powers to make decisions on behalf of the family and will be expected to be the communicator with the extended family. Some decisions (as accepted by the family) may require the consent or ratification of the extended family. The board acts much like a board of directors and therefore will hold regular meetings (e.g. quarterly) with formal notices, agendas and minutes. It is possible for board members to rotate within the family or for younger family members to serve on the board without too much responsibility and under the guidance of older family members. There may also be sub-councils which are responsible for particular matters such as investments, education, charity or accounting.

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DIFFERENCES BETWEEN FAMILY GOVERNANCE AND FAMILY TRUSTS

It is worth noting the two main differences between family governance and traditional family trusts. The biggest difference is that with a family trust, only the settlor creates it, including its terms of operation, distribution of profits and investment without any contribution from the extended family. Additionally, trustees are required to follow the terms of the trust (perhaps with the guidance of a settlor’s letter of wishes) and thus beneficiaries have little say in how the trust is managed and/or invested. . Therefore, ultimately, control is the fundamental difference. Given this, is it possible to integrate the two?

INTEGRATING FAMILY GOVERNANCE WITH FAMILY TRUSTS?

A family constitution will have little, if any, impact on how trustees administer family trusts established by a settlor. Therefore, integration will rely on trust documents reflecting family requirements and this can only be achieved through discussions with extended family. Here are some integration examples:

Trustees – Trustees can be appointed and removed by the family council or a representative committee of the extended family who are the beneficiaries of the trust. Alternatively, a family council could act as co-trustee. The most common alternative is the use of a private trust company to act as trustee and which allows the family to act as trustee and have control subject to the incorporation of the company of private trust and the terms of the trust.

Advisory Committees – the family council or other formed committees may hold regular meetings with the trustees who may also require the prior consent of a committee before taking certain actions (eg an investment committee). Alternatively, some committees might be able to direct the action of trustees, for example, distributions to charities.

Dissemination of information – trustees could be required to send information to beneficiaries on a regular and confidential basis, beyond simple financial information, but including information on future proposals, for example.

Dispute Resolution – Often a beneficiary’s remedy against the trustees is to bring a lawsuit. Instead, the trust instrument may provide tailored provisions for resolving disputes between trustees and beneficiaries. For example, trustees could be required to meet with the family council or a trusted third party to determine the dissatisfaction and reach a final, binding decision.

CONCLUSION

Family governance is a fundamental issue for any well-to-do family that wishes to perpetuate its heritage. The starting point is communication and the need for the family to understand that they need to take steps to regulate themselves and how they interact with their wealth. From there, the important aspect is a sense of inclusion by family members and that they are all on the same side. This will hopefully lead to unity with the family, allowing them to put their energies into moving forward together rather than against each other. Although family governance cannot entirely eliminate family conflicts, it can certainly strengthen the position of the family and, in the process, preserve wealth for future generations.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

Helen D. Jessen