It might seem that the operation and management of family firms is easier than in the case of corporations without family ties, thanks to the close personal ties of the people who participate in their operation. However, the opposite is often true. It is close personal relationships and emotional ties that sometimes help to bridge difficult situations, but at other times can be the root cause of misunderstandings or disputes. Along with the rise in the provision of specific legal advice to family business owners, some new tools and institutes are becoming increasingly common. One of such institutes is the family constitution.
It happens that the phrase “family constitution” at first glance gives the impression that it is only a kind of shiny, showy document whose real meaning is minimal. In the following lines, we will try to outline that this is not the case and that a family constitution should be increasingly important in contemporary society.
What is a family constitution
In general terms, a family constitution is a written document that is entered into between family members in relation to a family business, usually carried out through a family business. A certain specificity is that, unlike most other documents, it is not only the final wording of the family constitution that is important in the creation of a family constitution, but also the entire process of its preparation. In many cases, it is the process of drafting the text and the mutual discussions between family members that allow family members to overcome any barriers and to imagine and ideally reconcile their ideas about the direction of the family business and the roles of individual relatives in it.
Applying the family constitution
The purpose of the family constitution can be seen in particular in situations where a large number of family members are (or may be in the future) involved in the management of the family business. The family constitution can be seen as the binding force of the family business, uniting the individual family members and their ideas about the joint business.
One typical application of the family constitution is the creation of such a document at the beginning of the process of handing over the family business to the next generation. In such a case, the family constitution represents a kind of centrepiece of the whole process, familiarising all the persons involved with the conditions and principles according to which the handover will take place.
Content of the family constitution
In terms of its content, a family constitution should not be unnecessarily broad. It should be formulated simply and, above all, unambiguously. The basic building block of a family constitution is the definition of the main visions, principles and values of the family, but it is equally important to establish a hierarchy between these principles and values, i.e. a ranking of the relevant priorities and values from the most important to the most supportive. This is the basis for adjusting the more specific questions. These include, in particular, setting the rules, conditions and modalities for the transfer of family property from one generation to the next.
In addition, the family constitution may set out general principles as well as more specific provisions concerning communication between family members on business (work) matters, the philanthropic treatment of the family business’s funds or the ways in which the family’s business know-how is preserved.
Beyond this, family constitutions normally contain basic rules for the resolution of any family conflicts and disputes, both within the family members and externally, for example vis-à-vis the family business. In this context, the family constitution may include the designation of a specific person (e.g. a family acquaintance respected by all members) who will act as a family mediator or arbitrator in the event of a dispute.
“Emotional” binding
It should be borne in mind that the family constitution is a document which, in view of its content, is generally not legally binding and therefore any breach of the obligations enshrined in the family constitution by a family member is not legally enforceable. However, this certainly does not mean that it is merely a negligible “piece of paper”.
With a family constitution, the respective members of the business family will sort out their ideas about the functioning of the family business and the roles of the individual members within it, as well as, for example, the detailed intentions of the owner of the family business with regard to the handover of the family business to the next generation. All of this is done through a document whose careful preparation and written form is, at the very least, more “emotionally” binding than any verbal communication. The family constitution thus makes it possible to avoid many of the negative surprises and disputes that can arise, particularly in connection with the handing over of a family business, and which, as a result, can fundamentally jeopardise not only the business but also the cohesion of the family itself.
At the same time, in the context of the “emotional” aspects of a family institution, it is necessary to exercise some caution, as the intention of a family member to create a family institution may be met with misunderstanding and distrust from relatives. They may perceive the family constitution as a document which imposes obligations rather than clear advantages and which inappropriately regulates personal family relationships. The process of drafting a family constitution should therefore not be rushed and should be given considerable care.
Linking the family constitution to other legal institutions
Given its nature, it is highly recommended that the family constitution be integrated into a substantively linked ‘package’ of several legal institutions, such as a structured will, a shareholders’ or shareholders’ agreement of a family company or a trust. Through these institutions, family relations can also be regulated in important areas in a legally binding manner, which further enhances the importance of the family constitution.
These areas, which can be regulated by one of the other legal instruments, include, for example, the following: (a) issues of the treatment of shares in the family business (limitations on their transferability, methods of termination of the ownership interest in the company under the good leaver and bad leaver rules and other institutes standardly applied in shareholders’ or partners’ agreements), (b) the management of the family business and its representation in terms of setting the competences of the individual bodies of the family business (e.g. (c) the issues of handling the selected assets of the family firm through a trust fund and the related setting of detailed rules for the disbursement of funds deposited in the trust fund to the relevant beneficiaries in its statutes and bylaws.