Podcast S4E3 | Contentious Trusts & Estates: Family Disputes Involving Companies

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Podcast S4E3 | Contentious Trusts & Estates: Family Disputes Involving Companies

Podcast S4E3 | Contentious Trusts & Estates: Family Disputes Involving Companies 1920 700 Alfred Ip
Reading Time: 12 minutes

Alfred Ip and Geraint Ho discuss how family businesses and asset-holding companies can add another layer of complexity to family wealth disputes. They share common scenarios of wealth disputes and some of tips on how to best avoid these situations when setting up a family company or when planning its generational succession. 

Show Notes
00:57 The purpose of asset-holding vehicles
06:36 Family business and generational succession
11:06 Articles of Association
13:55 Common family business disputes
18:18 Valuation of a business
20:04 The importance of proper Estate Planning


TRANSCRIPT

Tune in for Series 4 of The HIP Talks podcast: a series of discussions on legal issues hosted by Hugill & Ip Solicitors – an independent boutique law firm in Hong Kong providing bespoke legal services and exceptional client service to individuals, families, entrepreneurs and businesses, locally and internationally. Clients have diverse issues: some require immediate attention and speedy outcomes; others require the building of a long-term partnership between solicitor and client. In all situations and for all clients, Hugill & Ip provides clear practical advice to help achieve the best results. The firm has achieved outstanding recognitions in the most recent editions of the major legal directories, as well as remarkable results in the areas of Dispute Resolution, Corporate & Commercial, Trusts & Estates, Family, Employment & Business Immigration and Data Privacy.

Geraint Ho  00:52
Hello, I’m Geraint Ho, and I’m here today with Alfred Ip.

Alfred Ip  00:55
Hello, Geraint. How are you?

Geraint Ho  00:57
I’m good, thank you. Today we will be talking about family disputes and how companies can be involved in these disputes. Now, as we know, Alfred, many people choose to hold assets under their own names, and that is the usual case around the world. However, in our experience, we also come across a lot of cases where the family wealth is held in corporate vehicles or companies. Could you give us a little bit of context or some of the usual reasons why some of the family assets are usually held in corporate entities rather than under their own names?

Alfred Ip  01:31
I will put it this way. There are many benefits for using asset-holding vehicles to hold assets. And in this respect, let’s not talk about family company, what we mean is an operating business. Operating business is a little bit complicated, which we will touch on a little bit later. But first of all, using a corporate vehicle that is a limited company to hold assets have a lot of distinct advantages. And many people have been using this class structure for many years, I can give a little bit more background as to, for example, buying a real property in Hong Kong. If you’re using an asset-holding vehicle to hold it, instead of registering under the name of the landlord or the owner, the big benefit is to sell it later on.

Alfred Ip  02:24
In Hong Kong, when we are talking about selling real properties, there is a stamp duty which a lot of people are keenly aware of because it’s escalating with time. In the past, we’re talking about a few percent of the property value, now we are easily talking about 15% in respect of residential property, when this transferred to another person who is already owning a residential property, the purchaser needs to pay 15% of stamp duty. Clearly, there are many ways to avoid that. One of the ways is to buy the property held in companies’ name with buying the shares instead of the property itself. And we are talking about a 0.2% or now 0.26% instead of 15%. You can see the distinct advantage of it and this is the reason why asset-holding vehicles have been used fairly commonly. In the past probably 30-40 years in holding real assets or any other asset of value. The same applies when we’re talking about bank accounts, especially in private banks, when we’re talking about like multimillion-dollars of assets portfolio including stock and shares, including also investment in private equity and all sorts, using assets-holding vehicle can have the effect of putting everything in one basket to have one of the person or two people which are about to hold the assets and control the assets held by the company. So, there are definite distinct advantages when we’re talking about using assets holding vehicles to hold assets.

Alfred Ip  04:09
Another context we’ve just touched on is family companies: and family companies obviously can leverage on the asset-holding vehicle when you’re talking about operating business. The Common Law system has this beautiful idea of separate legal entity. Using a company as the business-operating vehicle can effectively shield against liabilities that may be attracted in the course of operating business. Not every business operates at a profit. Sometimes it may suffer a loss, but in current liabilities of the company instead of the owner himself or herself can limit the exposure of liabilities. Therefore, it is always advisable to use a limited company to operate a business, but then when we are talking about more than one person holding a business, there will be shareholders and a lot of times what we have come across now is that a company that has been operated for years and now left to the successor, to a second generation, and there are probably more than one successors, and then probably more than one family members. And in these circumstances, when the shareholders are often family members, a lot of times the dynamic will be very different from, for example, two business partners who go into a business with two of them as a what we call quasi partnership.

Alfred Ip  05:47
For family members, the unique feature of it is that you cannot choose, you cannot choose family members and when disputes arise among family members, you cannot blame yourself that “oh, I met the wrong person and this person is not the person that I should have gone into a company with or doing business with”. And especially when there are family members involved, there are a lot of background, a lot of emotions involved – when disputes arise, things can become very ugly. And there’s one thing that family companies are commonly lacking: a shareholders agreement, which lead to a lot of disputes arising and members do not know how to resolve it. And therefore, we have this topic today.

Geraint Ho  06:36
Well, that sounds like a lot to take in, Alfred. So, let me just go back a little bit where you mentioned things like shareholders and shareholder agreements, could you tell me a little bit more about how in your experience these companies are run, and the roles of different family members in these companies?

Alfred Ip  06:54
Okay, I can give you an example, a fairly successful businessperson running his business for many, many years, knowing the business inside out. The last thing that he wants is to give it all up before he can no longer operate the business. So, either he has a succession plan to leave the business to one or maybe two of the family members, usually the second generation; he groomed them after educating them, paying for all the educational expenses, getting them graduated, and hopefully one day they will succeed in the family business. But not all of them will become business owners, not all of them have the business acumen, not all of them want to become a business owner. Some of them are for different reasons though, for example, the traditional Chinese value of business should be passed on to the sons not the daughters and situations arise: some of the people in the family will be taking an active role in managing the business, voluntarily or involuntarily. And some of the family owners, business members would be enjoying the fruits, or they have their own way of living. They serve their own family, they build up their own career, and they have no involvement in the family business. But in the patriarch’s perspective – patriarch means the business owner who founded the company in the first place – he wants to be fair, by being fair, he would spread and distribute his shares to the family members, let’s say he has two sons and one daughter: the two sons are running the business and the daughter is married and has her own family. So, she’s not involved in the day-to-day business, and lets the two brothers in her point of view, to run the business. In that kind of situation, the so-called silent partner – the daughter – may or may not become the director of the company. And in that respect, the major difference would be whether she would have control or involvement in the overall company management. If she’s not in the board, her right to the company’s information would be less compared with the directors. And that is exactly the situation that a lot of second generation will be in. They are not keenly aware of their role in the company, but they want information because the last thing that they want is to have someone taking advantage out of them. They only want their fair share. How can they protect their own interests? Especially, for example, from the two sons’ point of view, they are running the business, they may grow it, they may make it even bigger than at the time when they inherited the business, they consider themselves the contributor to the business success. And probably the last thing they want is to share such success with someone who is not involved in the daily operation and merely gets benefit from it because she’s some family members. So how does this daughter protect herself, while the sons consider it fair to distribute, or to share this success with the daughter would become a very hotly disputed subject, and therefore a lot of times we see dispute arising out of it and a lot of the litigation and ensue…

Geraint Ho  10:53
Right, Alfred. And now it sounds like that a lot of these companies are sort of very informally run by the head of the family. But shouldn’t there be some basic or baseline documentation in the company records?

Alfred Ip  11:06
You mean articles of association? Yes, it is something that every company must have. And it is something that a lot of times is proforma that is following a preset precedent. It is not tailor made for a particular company, or in some situations when companies were formulated a very, very long time ago, the company articles may not be up to date. And therefore, a lot of situations cannot be properly governed or determined with the assistance of the articles in the association. It is supposed to be articles of association. So, if the association has changed, such as inclusion or addition of family members, and the articles are not updated, then there might be a problem.

Geraint Ho  12:01
Could you give some examples of what these problems are in your experience?

Alfred Ip  12:06
For example, when we are talking about formation of a company, formation of quorum for board meetings and shareholders meetings, a lot of times in the past there is a minimum of two directors, but the law has changed. Now it’s possible to have only one director. But at the same time, if the articles are not changed and updated, when there are family disputes, articles may be abused to impede any meeting from taking place. And this is one of the many examples are very common in shareholders disputes, but in the family setting is particularly nasty.

Geraint Ho  12:53
Are there any particular reasons why you think these tend to be nasty?

Alfred Ip  12:59
Because, first of all, some people when they’re facing disputes, it’s particularly embarrassing for them to see each other face to face. And if a meeting is supposed to be conducted face to face, then it may not be the appropriate forum for family members to resolve the dispute.

Geraint Ho  13:22
But don’t family members now tend to use Zoom or conference calls a lot more now that we have technology, especially during COVID.

Alfred Ip  13:29
Yes, but this is something that only becomes available or popular after COVID. And in the past, there’s no such thing as Zoom meetings. A lot of articles of association do not govern this kind of meeting to take place via internet means and whether it can be conducted as such, can also become a disputed item.

Geraint Ho  13:55
It also sounds like there are a lot of traps or pitfalls where family members can fall into and these would open up a lot of disputes. Now could you tell us what are the usual consequences when a dispute arises?

Alfred Ip  14:11
Usually, the member who are excluded from the management of the company would take the first step by seeking account of the company, then it very much depends on whether he is also a director of the company or not. Because if he’s only a shareholder, his right of access to information of the company is relatively limited. But then it is only like the first episode of a proper family dispute. A lot of times the reason for seeking those account is to assess to genuine value of the company. After knowing how much is worth, he or she would like her shares liquidated, but then who is going to buy the shares? Either other family members or outsider. But would any outsider buy a share or percentage of shareholdings of a family business run by a family? Very unlikely. And then what to do next? If the other shareholders or family members are not willing to buy him or her out, what can they do? They often go to court. But by going to court and asking for himself or herself being bought out, serious allegations might be made against those who are in control of the company. And when serious allegations are made against family members, it becomes particularly nasty,

Geraint Ho  15:43
Right, and I think what you’ve just described here is a situation where one of the silent partners, as you said, feels like they’re being excluded or being kept in the dark from what’s going on in a company. Now, I’m also thinking about a situation where it’s the people who are running the company who have disagreements with each other, are there any consequences when that happens?

Alfred Ip  16:04
This is also very complicated in the sense that when both parties are actively managing the company, they may not have the same directions, or they may not share the same vision. And when they cannot decide among each other, how the company can go, dispute arise as to who should be exiting, or who should be buying who out, or who should be keeping the name that has been built by their father, or even grandfather over generations. And that would be to dispute arising out of, for example, Yung Kee, two branches of family members are fighting each other out, talking about who should be exiting or whether one party or one branch of the family has been unfairly prejudiced against each other. And at the end of the day, what did happen is that one branch of the family got bought out.

Geraint Ho  17:00
Right. Now, you mentioned buyout again. But I heard your previous point where you raised the question of this is a family company and who is going to buy the shares, either family members, or while nobody else really because, as you said, an outsider really doesn’t really have an interest in buying a family company. So, buying out a shareholder now it sounds to me like it takes a lot of money. But what if what if the family’s assets are all locked up in that company, and they don’t actually have the cash to buy you out?

Alfred Ip  17:32
Well, if there’s no agreement as to how and who to buy out who the only way to out, it would be to wind up the company. It will be very sad to put the company business founded by the patriarch, and then stopped by the next generation, but then in the absence of any agreement among family members, probably that is the only way out. By winding up that means the company basically is closed, all the assets will be liquidated, all the liabilities will be settled, and anything left would be shared among family members in accordance to their shareholdings.

Geraint Ho  18:18
That does sound like a very unfortunate or shall we say, a nuclear option indeed. Going back to the point about a buyout, is there any way that the courts or the parties themselves use to value the shares of the company and such the buyout price?

Alfred Ip  18:36
It very much depends on what the company is holding. If we’re talking about real assets, like an office or a property, or even a shopfront is kind of easy. All you need is to be referencing to the market value – with or without assistance of a valuer or surveyor, but if we are talking about the core a company of ongoing concern, then the valuation can become tricky, because according to our experience, a lot of valuations of the company would be referencing to similar business, similar industry, but for listed companies. How they are going to value the company would be very different from valuing a listed company and by listed company it means that a listed company has their resources, manpower, governance, and all this. A lot of times valuation will become quite high, and whether the assisting other family members or shareholders can buy them out would become another issue that has to be resolved.

Geraint Ho  19:43
Right and this at the end of the day sounds all very complicated and I’m sure we all want to avoid such a situation happening to ourselves. You know, as a takeaway for our listeners, do you have any tips for anyone who wants to start a family business or set up a family asset-holding company so that we can avoid these kinds of situations in the future?

Alfred Ip  20:04
What I will say in this respect is for the patriarch, it is part of his estate planning process. Estate planning is not just about a Will, is not just about setting a Trust. If there are assets-holding vehicles spreading the shareholdings among the second generation, equal or not equal may not be the right solution. If there will be more than one family members taking a stake in the family business or asset-holding vehicle, I would highly recommend them to put in a shareholders agreement. Just because they’re family members doesn’t mean that they should not be entering into an agreement like business owner or shareholders. A shareholders agreement can help them be solving some of the situations like voting, casting vote, board meetings and decision making, and most of all, there are exit that some of the family members may want and what would be the mechanism in determining who to buy who out and how much it should be bought out.

Geraint Ho  21:17
And apart from shareholders agreements between the family members are there any other measures that can be taken?

Alfred Ip  21:22
A lot of big families will also consider setting of Family Governance governing who can enter into the family business, who can enjoy the fruit of the family business, who will be excluded, what sort of conditions are family members must adhere to, in order to enjoy the dividend of the family business. And also to have family governance also allows family members to hold on to a core value of a family. Last but not least, setting up a Family Trust may also help holding family members together with a professional who has years of experience managing a Trust. That person would not only administer the Trust, but also as an outsider, joining family meetings, guiding them through the right directions and helping resolving any issues within the family with their professionalism.

Geraint Ho  22:28
Thank you, Alfred. And I think today we’ve covered a lot of ground on how family businesses and family companies can add another layer of complexity to a family wealth dispute. Thank you also, Alfred, for sharing some of your tips and tricks for how to avoid these situations if we are in a position to set up a family company or family business.

Alfred Ip  22:51
Thank you, Geraint. It has been a pleasure talking to you.

22:55
Tune in and listen to more episodes of The HIP Talks podcast by checking the Insights section at our website at www.hugillandip.com and our channels on Apple Podcasts, Spotify, Google Podcast and Stitcher. They’re also available on Hugill & Ip’s YouTube channel. You can send comments and feedback to our email address hello@hugillandip.com. Please share The HIP Talks with your friends, family and business associates. This podcast is for informational purposes only. Its contents do not constitute legal or professional advice.

 

This podcast is for informational purposes only. Its contents do not constitute legal or professional advice.

Alfred Ip

Alfred assists high net-worth individuals (HNWIs) in handling their wealth-related issues, such as contentious and non-contentious trust and probate, mental capacity, family office, amongst other wealth management matters. He is also a leading Dispute Resolution lawyer with over 20 years of experience in Hong Kong. Moreover, Alfred helps clients with issues regarding Family Law.

All articles by : Alfred Ip
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