Keeping a business in the family and out of court

By Natalie Myers, Staff Writer

A family business might seem like any other business. But when company shareholders have a disagreement about its direction, the problems can multiply. They can leak into Thanksgiving dinner conversation or explode at the nephew's birthday party.

And when disagreements about succession plans, stock sales or company planning snowball into litigation, the results can be "disastrous," said Mike Sweeney, corporate lawyer and managing partner at Duffy Sweeney & Scott Ltd. in Providence .

"It can become a personally difficult situation among relations," agreed Thomas Madden, owner and principal of The Madden Law Firm PC in Providence .

Both lawyers said setting up legal guidelines in the form of shareholder agreements and the like can help family-owned businesses avoid a tide of legal disputes.

A shareholders agreement, for example, can define how family members may sell their stock, Madden said. The shareholders may agree that any one of them wanting to sell must first offer the shares back to the company before any other shareholders or outsiders may purchase them. Without such an agreement, family squabbles can turn into costly court cases.

Another potential problem when a shareholder wants to sell: setting a value on the stock he or she holds.

"That's a very common pitfall," Madden said. The solution: "We would look to set a clear formula for determining value or set a provision for who would determine it." Sometimes appointing a third party, such as an accounting firm, to determine the value of a stock can prevent problems, he said. "Presumably, [the firm] would be more objective."

Shareholder agreements also can determine what happens when a family member/shareholder dies, is terminated, gets divorced, retires or goes bankrupt. That's why they are difficult agreements to get signed and "one of the most frequently left unfinished," Sweeney said. "People generally don't like to think of their own death."

Sweeney, whose practice is 75-percent family-owned businesses, said such documents should be put together at the beginning, because it's "much easier" to get things done before people have invested so much of themselves in the venture.

Geoffrey Grove, president of Pilgrim Screw in Providence , a third-generation family-owned business, said the company has no shareholder agreement in place, "but it's something we should think about."

Though Pilgrim Screw has not had to sort out shareholder issues with lawyers, Grove said "one of the biggest challenges" a family business faces is different agendas for the business.

Pilgrim Screw family members meet once a year to discuss where the company is and where it's going, he said. "That's one thing we do to avoid problems."

Madden said keeping "open lines of communication," especially when discussing succession planning, is the key to avoiding litigation over such issues.

"The best thing to do is communicate about it in a way that recognizes everyone's abilities," he said. "If someone feels boxed out, resentment builds up and litigation arises. So much of it results from emotion, even more so than dollars."

"We have encountered several situations where transitions in family business have not gone smoothly," Madden said. Many problems, he said, have to do with inadequate provisions in the articles of incorporation, bylaws, shareholder agreements and cross-purchase agreements.

Sweeney said companies that are "not doing succession planning, not having an agreement that determines what happens when a president dies" are the ones he sees having the most legal issues.

Planning for the future is "an ongoing process," said Steven Crandall, sixth-generation partner of Ashaway Line & Twine Manufacturing Co., which is more than 175 years old. "There are regular checkpoints - opportunities for the family to get together to discuss what the current situation is.

"It's all about communication. It's not something you can put on a shelf."

MOST CONFLICTS ARISE FROM ISSUES OF MONEY, CONTROL

William O'Hara, founder and executive director of the Institute for Family Enterprise at Bryant University , estimates that 90 to 95 percent of Rhode Island businesses are family-owned - a "high density" he attributes to the state's "history and smallness."

Based on 15 years of experience, O'Hara said he's found most of the conflicts in family-operated businesses result from issues involving money and control of the business.

"It's usually a history of animosity going back to childhood," he said. "Someone's nose is out of joint, and the first reaction is to take it to court."

That's where the IFE comes in, he said - to try to prevent family businesses from going to court. The institute provides assistance in developing succession planning, establishing open communication, maintaining harmonious relationships and developing next-generation leaders.

In addition to shareholder agreements, which he said are "indispensable," O'Hara advises family businesses to set up a board of advisers from outside the business to help with conflict resolution.

Published 08/12/2006
Issue 21-18