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Nip conflicts in the bud

by Anna Chan & Martin Tse

 

It is sad – but unfortunately not uncommon – when family members take each other to court over family business disputes. It is certainly undesirable to see any disturbance to a family’s harmony, but how can we nip conflicts in the bud? In this article, we will examine how corporate governance tools can be utilised to assist family business succession plans.

 

Learning from precedents

You may still remember when the Kwok brothers – who were once members of the board of directors of Sun Hung Kai Properties Ltd (SHKP), Hong Kong’s second-largest developer and a publicly listed company ­– resorted to legal proceedings to resolve their dispute over control of the company. In 2008, Walter Kwok, the eldest of the three brothers, applied to the Hong Kong courts for an urgent injunction to prevent the directors from voting to terminate his appointment as chairman and chief executive, and/or to re-designate him as a non-executive director. The injunction was dismissed on the basis that the court cannot interfere with board matters involving the internal management of the company.

 

While the SHKP case concerned a matter happening at board level, the legal initiative brought by Walter Kwok was ultimately a reflection of the difficulty with being a minority shareholder. Generally, the court cannot assist a minority shareholder to hold onto his or her directorship because ‘majority rule’ dictates under the present legal framework.

 

Another precedent case over control of a family business was seen with Yung Kee Holdings Ltd (YKHL), the ultimate holding company operating the Yung Kee Restaurant, which is famous for its roast goose dishes. Kam Kwan Sing (‘Sing’) brought a petition against his brother Kam Kwan Lai (‘Lai’) on the grounds that YKHL’s affairs had been conducted in a manner unfairly prejudicial to his interests, and Sing sought an order that Lai buy out his shares or, alternatively, that YKHL be wound up. In the end, the Court of Final Appeal made a winding-up order in 2015, which was stayed for 28 days for the parties to negotiate the terms of a possible buy-out (for which the parties failed to make an agreement). It was particularly unfortunate that the parties had in principle agreed to a buy-out arrangement but were unable to work out the details, notably the price. As a result, the winding-up of YKHL was unavoidable and the process was left to professional liquidators, who were outsiders to the family.

 

From the above precedents, we know that under the legitimate notion of ‘majority rule’, seldom does the court interfere with the affairs of a company in favour of a minority shareholder. Furthermore, although under the existing framework there are mechanisms to assist a minority shareholder against oppressive acts of the majority, reliance on such mechanisms is insufficient since this will often lead to uncertain or radical results that may not suit the purposes of the minority shareholder.

 

This may prove a problem in a family business succession. There needs to be something extra. For example, in the Yung Kee Restaurant case, such an outcome could have been prevented if there had been prior consensus over a shares buy-out mechanism in the shareholders’ agreement. Provisions can be made in advance to specify how a buy-out price is arrived at, whether by way of net asset value (NAV), multiplier-over-profit or a cash flow approach. Once the rules of the game are in place, shareholders are spared from any unnecessary debates and confrontations because they only need to follow the black-and-white terms.

 

A shareholders’ agreement, however, is just a tool, one that is based on the broader concept of corporate governance, which is a crucial aspect of any family business succession plan.

 

Corporate governance tools

Corporate governance – meaning the standardisation of the relationships between the company management, board of directors, shareholders and other stakeholders, which in the context of a family business includes family members who are neither directors nor part of management – is pivotal to ensuring the smooth operation of a company and to balance the interests of different stakeholders.

 

Corporate governance tools in a family business may consist of:

 

  1. Companies Ordinance (Cap 622). Cap 622 contains provisions regulating Hong Kong companies, as well as companies incorporated outside Hong Kong but which have established a place of business in Hong Kong.
  2. Articles of Association. A company’s Articles of Association have to be registered with the Companies Registry as public information, which does not favour the protection of family privacy, and should not be frequently amended.
  3. Shareholders’ agreement. A shareholders’ agreement will usually be signed by all shareholders and is often legally binding so that the company is governed according to a set of pre-agreed rules, and to ensure that shareholders can ascertain their rights and scope through the agreement.
  4. Independent directors/external consultants. Making use of independent directors or external consultants can safeguard the overall interests of the company, but is more suitable for larger family businesses.
  5. Trust operations/family office. This is better suited to family businesses that have grown to the second or third generation.

 

Shareholders’ agreement

There is no doubt that a shareholders’ agreement can address many of the corporate governance issues that arise in the process of a family business succession. A shareholders’ agreement is a contract concluded between all shareholders of a company in order to define their respective rights and responsibilities, and to organise the management of the company. It supplements the Articles of Association of the company by, among other things, regulating the relationship between the shareholders, the management of the company and the ownership of the shares. The shareholders can also effectively make use of the shares they own in accordance with the shareholders’ agreement, or make use of provisions to exit the company in a way that is acceptable to all shareholders.

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The timing of signing a shareholders’ agreement is important. In reality, one always comes across events that are wholly unforeseeable – such as death, mental incapacity, divorce or sudden crisis/dispute within the family. In general, the sooner a shareholders’ agreement is executed the better because unforeseen events or a family dispute could happen at any moment. Also, if a shareholders’ agreement is concluded at an early stage, when the number of family members is smaller (before its organic growth horizontally), unanimous consensus can be more easily attained.

 

Conclusion

Formalising the relationship between family members through contractual arrangements might sound odd to some; it may not sit well with the traditional Chinese concept of parenthood or fraternity. However, contractual terms do provide resolution (at least to a certain extent) to any potential future family disputes over a family business. It is better to nip conflicts in the bud than to see your long-lived family business go up in flames.

 
 

(This article first appeared in the August 2019 edition of CSj (http://csj.hkics.org.hk), the journal of the Hong Kong Institute of Chartered Secretaries, published by Ninehills Media Ltd.)

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