Families fight. That is inevitable. Naturally, when a family-owned business or a family trust is at issue, some level of conflict is to be expected. When these conflict-prone structures combine, the conflicts have the potential to be bigger, riskier, and costlier, and can have multi-generational effects.

This article will touch on why the risk of conflict is so high in the family business and family trust context, provide planning tips to reduce the risk of conflict, and outline important considerations for families and their advisors to keep in mind when family friction boils over into conflict and litigation.

The F-Word: Fiduciary

In both the business and trust context, fiduciary obligations are paramount. Company officers owe similar fiduciary duties to shareholders that a trustee owes to the trust beneficiaries, including the duty of loyalty and the duty of impartiality. Just as a company officer cannot usurp a company opportunity, a trustee cannot transact business with the trust for the trustee’s financial benefit. To do so would breach the fiduciary duties of loyalty and to avoid self-dealing.

In the family business and family trust context, family dynamics collide with these fiduciary obligations and with business necessities. A conflict that has its roots in a simple sibling rivalry or blended-family distrust can snowball into legal allegations of a breach of fiduciary duty when one family member assumes a fiduciary role over another.

There are many topics that breed discord when family members and fiduciary powers intersect. Some examples that are frequent sources of conflict include the appropriate level of compensation received by those working in the family business, which family member is best prepared to run the family business or to control the family trust, and whether trust distributions fairly balance business control with monetary bequests.

Because issues of money, power, and favoritism are often simmering beneath the surface in family-owned businesses, the layering on of additional legal obligations risks bringing the simmer to a full-fledged boil. 

Measures to Avoid or Reduce Conflicts

When considering succession planning, decision makers (typically the senior generation) must face reality about family dynamics and the personal relationships that shape them. The desire to have descendants run the family business is natural, but is often incompatible with objectivity or with the desire to avoid conflict.

1. Establish clear communication.

Whatever the senior generation ultimately decides about its estate or business succession plan, it should communicate the decision to those affected by it with transparency. Educating the beneficiaries of the estate should occur at least in summary form and, as a best practice, copies of the executed governing documents should be provided. With respect to business succession, regular reporting on the progress of the business and any changes to the succession plan should be communicated with regularity. Providing a structured forum for communication (such as regular family meetings on the topic of succession) also reduces the chances for later litigation.

2. Review and revise governing documents.

While open communication is helpful, it is rarely sufficient. Well-advised families will also review and revise corporate and trust documents to ensure to include specific provisions tailored to preventing or minimizing litigation. These may include safe harbor clauses (clauses to establish that certain actions or procedures are authorized under a governing document) and provisions for fiduciary exculpation (exempting fiduciary actions that do not rise to a serious level such as willful malfeasance or bad faith from liability), utilizing the Prudent Investor Rule (protecting actions that a reasonably prudent investor would have taken), the Business Judgement Rule (protecting the decision makers in a business document, not a trust agreement) and Voting Stock versus Non-Voting Stock (facilitating transfers of  the non-voting interests for estate planning purposes without distorting the voting control).

3. Utilize neutrals.

Families should also consider utilizing neutral parties such as a corporate trustee or an independent professional trustee. These individuals are neutral to the family dynamics, but are professionals in dealing with trusts. They understand the nuances and can help provide potentially more objective advice than could a family member trustee.

Even when the senior generation prefers that a family member assume a trustee or other fiduciary position, there is still a place to include a neutral. For example, trust documents may provide for a Special Business Trustee who would direct the primary trustee on decisions related to business interests, or a Trust Protector who is able to remove and replace trustees and exercise additional powers, such as changes in trust situs, without having to go to court to do so.

4. Consider alternative dispute resolution options.

Families and their businesses can also utilize guidance from a dispute resolution consultant or include provisions for pre-litigation resolution proceedings in the governing documents. These may include mediation, arbitration, or “baseball arbitration,” a style of mediation named after the method used in Major League Baseball contract disputes. In this style of mediation, each side submits a comprehensive proposal and the neutral chooses one proposal or the other in the entirety, without splitting the difference between the proposals. Requiring some method of alternative dispute resolution can ensure that all options for resolving the dispute are exhausted before proceeding to litigation.

5. Disincentivize conflicts.

Finally, a large incentive to reduce disputes is to simply make them too costly. This can be done through fee-shifting provisions, indemnification, surcharges, and (in states where they are valid), in terrorem clauses, which provide that anyone challenging the legality of the will or trust forfeits rights to benefit from it. The inclusion of such clauses in governing documents may sufficiently divert conflict away from the courthouse steps.

However, even the best planning cannot guarantee a dispute will not enter litigation.

Litigation Looks Likely—What Now?

1. Gather the right team.

First and foremost, it is vital to have the right team in place. When litigation looks like a possibility, get a litigator involved early. While that may sound like an obvious point, in practice, fiduciaries and beneficiaries often look first to their corporate counsel or the attorney who drafted the governing trust or corporate documents when disputes arise. It is an understandable impulse, but there are many reasons why it is advisable to retain a qualified litigator at the outset rather than relying on the corporate drafting attorney.

For example, there will very likely be conflicts of interests involved when either a fiduciary or a beneficiary seeks to engage the attorney who drafted corporate or trust documents to advise on disputes that have arisen relating to those same documents. Additionally, in the trust context, if a question arises relating to the settlor’s intent in establishing the trust, the lawyer who drafted it may be a necessary witness. Ethical rules prohibit an attorney from representing a party in a case in which the attorney would also be a witness.

Finally, it is important to remember that litigation itself is a specialty. Court rules, norms, and even the judge’s temperament can play a significant role in the outcome of a dispute once it goes to court. Litigators know all of these factors best.

2. Set realistic expectations.

When litigation looks imminent, set realistic expectations. Litigation is unpredictable, expensive, and public. Families who are used to their disputes playing out behind closed doors may be surprised to realize how much about their family business, history, and finances become placed in the public realm once litigation is initiated. It is important to understand this prior to launching a lawsuit because once information is made public, it is near impossible to “un-ring that bell.”

3. Determine scope of representation.

Another critical determination that must be made early on in a dispute is precisely which parties are or can be represented by the same attorney. This determination can be difficult in the family dispute context when, for example, one family member may rely on another to find and hire a lawyer. Often family members’ interests start out aligned, making a dual representation appear cost-effective and reasonable. However, more times than not, interests that begin aligned later diverge, making dual representation risky.

To add, there are several different rules that govern whether a lawyer is even permitted to represent multiple parties, including state ethics rules, probate code rules, trust code rules, and general common law rules. Fiduciary disputes will almost always involve multiple parties with both individual and overlapping interests which will complicate ordinary legal conflicts of interest analyses.

Relatedly, nuanced and unique attorney-client privilege issues arise in the context of fiduciary disputes. For example, depending on where the parties are located, a dispute between a fiduciary and a beneficiary could implicate the fiduciary exception. This exception to the attorney-client privilege provides that certain legal advice sought by a fiduciary is not privileged as to beneficiaries.

The exception has its origin in shareholder derivative actions, where it was determined that when officers of corporations sought legal advice, the shareholders were the actual beneficiaries of that advice and should therefore, be permitted to discover those communications. Certain states have since expanded this exception to cover trustees and trust beneficiaries. Whether in the trust or shareholder context, fiduciaries must understand the possibility that advice they seek from their attorney may not be privileged as against parties with whom they may later find themselves in a legal dispute.

4. Identify deadlines and causes of action.

Finally, when family fiduciary disputes arise, promptly identify deadlines and available causes of action. The deadline to bring some fiduciary related claims can be as short as six months, and many state statutes are vague as to when that six-months-time clocks begins. Determining immediate deadlines, along with ensuring the right legal counsel is retained and possible conflicts of interest and the proper scope of representation identified, are just a few of the critical steps that should be taken as early as possible when fiduciary related disputes emerge.

The Bottom Line

Fiduciary obligations take on additional considerations and risks when family-owned businesses and interests are involved. As a result, plan ahead as if disputes are inevitable (or at least predictable). This will aid in minimizing the risk that ordinary family business conflict turns into family courtroom conflict. And if, despite best efforts, the family conflict veers toward litigation, contact your litigator.

For more information on succession planning and conflicts issues relating to family-owned businesses and fiduciary litigation, contact Meghan Tepas or Michael Whitty.