Widening the family circle

Owners of family businesses often shy away from appointing independent executors and trustees in their last will and testaments because of the perceived high costs
and the desire to ‘keep matters within
the family’. However, many beneficiaries
find out that the failure to appoint
an independent trustee can lead to
bitter and expensive disputes for all parties concerned.

Shares in such businesses are usually held by a number of family members. Each one tends to make their own will leaving their shares to specified individuals, often their spouse and children. For tax reasons, the shares are usually left in trust.

Frequently, the spouse (who is often a beneficiary) will be appointed as a trustee, together with the family members who are still involved with running the business. The intention is that all the parties will work together for the benefit of both the business and the beneficiaries of the trust, with limited cost to the trust and minimal interference in the family business.

Unfortunately, conflicts are increasingly common. Disputes often arise between the beneficiaries of the trust and the remaining family members running the company. This is particularly so when the various parties hold equal shares. The trustees managing the business often perceive it as their own, so they grow to resent and resist any involvement or requests for information from the beneficiaries and will not engage with them over the direction.

Disputes of this nature arise frequently in second-generation firms following the founder’s death. They can arise for many reasons but invariably are based on past underlying rivalries, different perceptions of who the company rightfully belongs to and who contributes the most to that business. Such frictions are often diluted while the founder is alive, making
key decisions and directing strategy.

However, when the founder dies and siblings are left to run the business, old tensions quickly come to the surface. Grief at the loss of a parent coupled with the fact that they have to make decisions quickly can often lead to conflict and strains. This is further exacerbated when they hold the position of trustee and must reach agreements in respect of
the trust, making decisions in the
best interests of the beneficiaries.

Sibling rivalry

My firm recently acted on behalf of a second-generation family-business owner’s widow. Her late husband had been a director and shareholder of the company, which had been set up by
his father and become a successful
£15m business over three decades.

The father left the business equally to his three offspring, one of whom had taken over as managing director and the second of whom, the widow’s late husband, had taken on a secondary role. The third had never worked in the business, was wealthy in her own right, and had little interest in the family firm.

When her husband died suddenly, only two years after his father, he left his one-third shareholding in a discretionary trust for his wife and their son. The wife was a trustee along with her husband’s brother, the managing director.

On the surface, the wife’s husband and brother had appeared to get on reasonably well – after all, he had appointed this brother as a trustee to look after the best interests of his wife and child in the event of his death. However, following his death, the brother did not appear to act in his sister-in-law’s or nephew’s best interests.

Despite many requests by the wife for company information, mostly
relating to anticipated dividends,
only minimal detail was provided.
No trustee meetings were held and
no trust accounts produced.

The surviving sibling viewed the company as his own, refused to provide any information and paid only limited monies into the trust by way of dividend payments – even though the company was extremely successful. Despite his duties as a trustee, he also attempted
to purchase the shares from the trust
at a significant undervalue.

Eventually, the wife sought legal advice and steps were taken to remove the managing director as a trustee from the trust (see sections 36 and 41 of the Trustee Act 1925). Under section 41, the court may appoint a new trustee when it is found inexpedient, difficult or impracticable to do so without the court’s intervention. The court has the power to remove a trustee against their will and appoint someone else in substitution.

The court also has inherent jurisdiction outside the Trustee Act to remove a trustee. In exercising this jurisdiction, the court prioritises the welfare of the beneficiaries and the competent administration of the trust
in the beneficiaries’ favour.

However, hostility alone between
the trustees and beneficiaries is not a good enough reason to remove a trustee. The hostility has to be such that the proper management of the trust is effectively stymied.

Significant costs

For these reasons, it can take time to remove a trustee. Correspondence needs to be built up demonstrating that the trustees are unable to administer the trust together and that the position of the beneficiaries is being prejudiced. Courts do not remove trustees lightly as they take into account that the deceased chose the individual as trustee. While, in the example mentioned, the trustee eventually agreed to retire from the trust rather than defend removal proceedings, the process was long with each party accruing significant legal costs.

The whole dispute was finally resolved with an independent trustee being appointed and the shares being purchased for fair value with the proceeds being paid into the trust.

Part of the difficulty in such situations is that the parties are often completely unaware of their duties as trustees and, in the wife’s case, their rights as a beneficiary. These duties are onerous. Trustees are bound by the terms of the trust deed, the Trustee Act 1925 and Trustee Act 2000, which impose a duty of care on them.

Subject to terms of the trust deed, trustees are under a duty to review the suitability of the trust investments (considering whether to diversify risk), take advice where needed in respect of the same and apply their own judgement. Their overriding duty is for the benefit of the beneficiaries. Breach of these duties can leave a trustee open to personal liability for a breach of trust claim.

The above conflict may have been avoided or resolved more quickly if an independent trustee had been appointed. The independent trustee could have requested the relevant company information from the surviving sibling and reviewed the suitability of the trust’s investment (being the company shares) assessing whether the shares were an appropriate investment for the trust. They could have done this without vitriol and conflicting priorities.

Unlike trustees who are also beneficiaries, independent trustees remove the emotion from the situation. They can listen to all opposing points of view and are much more likely to make rational decisions that the other parties more readily accept, given that an independent trustee has no personal interest in the outcome. It is easier for them to focus solely on the benefit of the beneficiaries, which is a trustee’s statutory duty.

Protecting beneficiaries

While many testators appoint family members because of the perceived
costs of independent trustees, the reality is that an independent trustee can save valuable time and costs. Provided there are no unforeseen problems, the cost of an independent trustee can be kept to a minimum. Where action is required by shareholders, fees are charged on a time-spent basis.

Family businesses need an experienced trustee to ensure a balance is struck between incurring too much time so charges are disproportionate and incurring not enough time so as to expose trustees to criticism and possible personal liability for not protecting/maximising the assets for beneficiaries.

While many family businesses have thrived on the fact they have kept shares within trusts governed by family members, there is merit in appointing an independent professional as a trustee who will be fully aware of their duties as a trustee and who will ensure everyone’s best interest is served at all times.

Nicola Marchant is a partner specialising in contentious trusts at Pannone