Dear {First Name}

Welcome to the September 2008 edition of The Director’s Dilemma newsletter. I hope you are finding this year’s series interesting, informative and inspiring.

I advise Boards and Directors on complex and challenging issues which can be resolved in a variety of ways. Each way has different pros and cons for the individuals and companies concerned. Every month this newsletter considers three experts’ responses to a real issue. Which response would you choose?

Here is this month’s ‘mini case study’:

Tim is a director of a family business. His fellow directors are his brother and his brother’s wife. He and his brother each own 40% of the shares and the remaining 20% are held in a trust for the grandchildren of the founder, Tim’s deceased father.

Tim is the managing director and his brother is non executive chairman. Both are over sixty years old.

The company has grown and is profitable. It has a professional management team and Tim is aware that soon he will need to start planning for succession. Tim’s brother now wants his son (Tim’s nephew) to be employed as Marketing Director and put onto the board. The son/nephew worked at the company previously, was difficult to manage, expected a high salary and did very little. He is 24 and has no marketing, business, or governance qualifications.

The Chairman and his wife have both voted to employ their son and Tim has caused a major family row by speaking against the proposal. The proposal has been deferred until the next board meeting in three months time. Tim is concerned that, as the company constitution states that all decisions on hiring and firing company members must be taken by the board, he will be outvoted and forced to accept. He is also concerned that his nephew may aspire to succeed him as MD and knows that the management team would not remain under those circumstances. Tim is relying on the dividends from the company to fund his retirement.

What should Tim do?

Michael’s Answer

As it is a family company situation, Tim’s first option is negotiating with his brother and sister-in-law a resolution to the dispute to maintain good family relations. Failing such a resolution Tim then needs to consider what legal options there are available to him. Another possible option is to sell his shares in the company to his brother at their fair market value.

As 20% of the shares in the company are held on trust for the grandchildren of the founder, there may well be provisions in the late grandfather’s will dealing with how the business was to be operated after his death.   Alternatively, there may be a separate agreement which is sometimes described as a ‘business management succession agreement’. This is an agreement signed by all family members involved in the business and forms an integral part of the grandfather’s estate planning. The document sets out how the business is to operate on the grandfather’s death and it covers issues like dividend policy, family disputes resolution and states that the business is to operate for the benefit of all relevant family members. If such a document exists and Tim’s brother is a party to it then he is bound by the agreement.

Alternatively, if Tim’s brother is one of the executors of the grandfather’s will then there is every chance he is one of the trustees of the trust for the grandchildren. If so, he is bound by the NSW Trustees Act to avoid any conflict of interest otherwise he may be in breach of trust.

Finally, Tim has to consider legal action under the Corporations Act and common law alleging breach of a director’s fiduciary duty to act honestly and in best interest of company by his brother and sister-in-law. Directors must act in good faith and this includes acting in best interest of all shareholders. There are many possible actions arising from these facts but most notable a breach of the provisions of section 232 of the Corporations Act alleging oppression, unfair prejudice or unfair discrimination by Tim’s brother and sister-in-law against the other shareholders.

Michael Roberts is a Solicitor and Barrister at Clarendene Estate Planning Lawyers, Sydney, Australia.

Julie’s answer

Tim needs to think strategically. He has conflicts between his desire to keep the peace in his family, his professional pride in a well run company, his duty as a director to take decisions in the best interests of all shareholders (not just himself), and his wish to see the company prosper under the management team he developed.

It is constructive and appropriate to refer family employment issues to an independent and professional board that can balance the needs of the shareholders and the business. Tim’s board needs to be properly constituted with independent members who are devoid of conflicts of interest, and a well written charter. If this nephew is the only member of the next generation willing to work in the company then the board needs to plan for the future. The shareholders need to relinquish their current habit of direct intervention in the company.  

It is a common misapprehension that marketing is a good place for people who only want to party; but it’s not true. If his nephew wants to work in marketing, he should learn this discipline.

Tim could open discussions with a plan for grooming the nephew quickly until he can claim a management position without offending the professionals. In return the nephew should agree to performance management whereby outcomes are measured and a lack of effort will result in removal from employment. An HR professional can draft this plan and suggest on the job or formal training solutions.

Salaries in family businesses may be higher for family members than the usual market rate. As long as all is properly accounted for and declared, the remuneration can be set by negotiation.

I wouldn’t advise a ‘die in the ditches’ opposition to employing the nephew. Tim should seize this opportunity to gain leverage with the current board and move to a separation of the roles of management, shareholders and board so the company can operate more effectively.

Mark’s Answer

I think that Tim has to fulfill his role as Managing Director and look out for the interests of the employees and their customers. Although he may lose the battle he really has limited options. If his nephew is added to the Board he is in a situation where they control an overwhelming majority.

He should be straightforward with his family about his reservations. As a compromise he might suggest a ‘developmental role’ for his nephew with a professional mentor to assist him in gaining the skills to become competent at the position he aspires to.

Depending on how creative he wants to get, he might even propose a course of study like an MBA to broaden his nephews experiential base and propose an associate (non-voting) board role as he ‘apprentices’ for the role.

It appears the nephew is the only family member of his generation that is active or seeking a role in the organisation. By proposing to work with the nephew to prepare him over a reasonable period, he may be able to create a win-win compromise with his family.

He could also ‘suggest’ his willingness to sell some or all of his stock to members of the management team to broaden the decision making and secure their commitment.

I believe the best strategy is the ‘training role’, that way he is saying to his family that he is willing to support his nephew with the appropriate training and preparation.

An issue to clarify is: who has the responsibility for voting the shares that are held in trust? Is it Tim as Managing Director? If so, although his brother and spouse are Directors he would be able to combine the value of his shares and the trust shares and hold a majority.

Mark Herbert is a Principal at New Paradigms LLC, Oregon, USA.

The opinions expressed above are general in nature and are designed to help you to develop your judgement as a director. They are not a definitive legal ruling. Names and some circumstances have been changed to ensure anonymity.

What’s New

Be an expert – I will post next month’s dilemma on LinkedIn. If you would like to have a go at advising just log on to my Q&A and type in your advice. I will pick the best answer to be published in the October newsletter.

Book review – Directors do a lot of reading. I keep a note of my thoughts on each book I read. Here is my review of The Dip by Seth Godin.

This newsletter – I will issue The Director’s Dilemma monthly in 2008 then evaluate how it performed. If you have any ideas for improving the newsletter please let me know. It is currently read all around the world and I hope to reach 20,000 subscribers soon. Please feel free to forward it to your board colleagues.

Suggestions for dilemmas – Thank you to all the readers who have suggested dilemmas. I will answer them all eventually.

Farewell until next month. Enjoy governing your corporations; we are privileged to do what we do!

Best wishes

Julie | PO Box 97 Killara NSW 2071
email | phone +61 2 9499 8700 | mobile +61 411 262 470 | fax +61 2 9499 8711