Should the family enterprise be owned in trust form?
Benefits of a Trust
Significant family enterprises such as the famed jeweler Harry Winston, the Pritzker Hyatt Hotel empire, Walmart and Nordstrom are (or have been) owned in trust form. Owning an enterprise in trust sometimes works well; other times it ends in costly, public and divisive litigation.
There are many good reasons to own a family enterprise in trust form: control of voting, control of beneficial ownership (protection in case of spendthrift, divorce, drug addiction, substance abuse, mental illness, unsustainable beneficiary lifestyles), protection from creditors, removal from taxable estates, avoiding probate, greater privacy, or avoiding turf wars among children or subsequent generations.
Careful Consideration is Needed
But in order to work, the terms of the trust must be thought through. Those serving as Trustees in management and leadership roles must understand the responsibilities, conflicts and liabilities that arise. A Trustee also serving as a Director of a business entity owned by the Trust, must understand how different the roles are and what the consequences are of acting in either or both roles.
This article will address important points for management of family enterprises owned in trust form to consider:
Questions that should be asked by anyone who takes on the role of Trustee or Director of a family enterprise owned partially or totally in trust form;
The importance of understanding the difference between fiduciary duty and business man’s risk.
The pressure points most Trustees and Directors face.
Strategies to mitigate conflict.
The evolving law on retaining inception assets in trust form (including investments standards, duty to diversify, and duty of loyalty).
Questions for Management
There are important questions that should be asked by anyone who takes on these roles:
Does the trust provide in its terms that the business entity may be retained in the trust? The Trustee should be wary of retaining a business interest unless it is specifically authorized by the terms of the trust. And even if that language is there, a Trustee may be justified in retaining a concentration in a family-controlled entity if that fits the trust purpose, but if the nature of the company substantially changes, the justification for retention of the asset may evaporate. The Trust can relieve the trustee of the duty to diversify but it cannot relieve the Trustee of the duty to act in good faith. The Trust must exercise prudence and caution and the Trustee may still be liable for failing to diversify if circumstances indicate that diversification is essential to protect the trust assets. A Trustee may be justified in retaining a concentration of the family enterprise if the interest cannot be sold (because of security regulations or because of provisions in a buy-sell agreement or if the only market for the sale would require a substantial discount.)
Is the intent of the Settlor of the Trust manifested in the trust itself? Without a clear statement, it is difficult to infer what the intent of the Settlor is. The Settlor may not have included the language because it was never explained to him, or decided to hold the concentration for tax purposes to mitigate capital gains or to build wealth, but had in mind at some point, as all evolved, to sell the concentration to provide increased income to beneficiaries, or at some point, when the Settlor is gone and who is in charge is unclear, that the wealth preservation be preserved and the asset sold for future values.
Notwithstanding what the Trust states, is it in the best interest of the beneficiaries to diversify the assets? Even if there is a mandatory provision to retain the investment, a Court can overrule that if doing so is in the beneficiary’s best interest.
Is the Trustee authorized by the terms of the Trust to also serve on the Board of Directors for the enterprise? Does it matter if that person is a family member/beneficiary or an independent Trustee/Director? The duties of a corporate fiduciary are more lenient than those of a Trustee and when a person is serving in both roles, what is the standard by which his/her actions should be judged? Business Man’s risk (applicable to corporate fiduciary) or the higher standard of Trustee fiduciary duty, which incorporates the duties of care and loyalty? What does the trust document state about these conflicting rules and the liability or indemnification of those who are serving in these capacities?
How does this Trust interrelate with the governance of the family enterprise? As Trustee are you aware of the corporate documents and what they say? To what extent can you and should you have knowledge about the finances of the family enterprise asset?
Carful consideration of the structure of any family enterprise will increase the strength of the buisness in the long run.