Corporate governance in family-owned enterprises

Stephen Morrall
Dawsons LLP

The UK Financial Reporting Council published its new Code on Corporate Governance in June 2010. Though it only applies to the top 350 FTSE (stock exchange listed) companies, it contains sensible principles that family-owned enterprises would do well to consider. One principle is regular review of the board. The Code requires all directors of public companies to submit themselves for re-election annually. While such frequent change would not be appropriate for most family-owned enterprises in which the role of the founder or the latest generation may be crucial, the danger that influential family members preserve their positions jealously and avoid the important task of grooming their successors needs to be addressed in other ways.

All companies need to have succession plans and good systems of governance. To this end, suitable procedures and structures can be entrenched in the enterprise’s constitution, such as setting age limits for retirement, requiring directors to submit themselves for re-election periodically (eg, every three years) and allocating voting power to reflect the respective influence of different parts of the family. Even in a family company, democratic processes are important. Among the appealing features of English company law are its flexibility and a relative lack of prescriptive rules which enable private limited companies to organise themselves in the manner which suits them best. If the family wants to keep these processes private, they can be incorporated into a shareholders’ agreement which cannot be inspected on the public register.

A company needs strong leadership and stable management. To achieve this, the directors need time to establish themselves in their roles particularly if they are technical and complex. Appointments should be made on merit and the family members will need to recognise their strengths and weaknesses. Where there are family tensions, a trusted, independent non-executive director can play an important role in bringing an outside perspective and moderating the family dynamics.
There are clearly risks involved in entrenching provisions into the company’s constitution. If elections have to be held too frequently, directors might be encouraged to take a short-term view and avoid making difficult and unpopular decisions which might be in the best interests of the company. The company would also risk losing people of the right calibre in key positions because of family politics.

Finally, family directors should have a well-drafted service agreement which defines his/her rights and duties and addresses what happens if he/she is removed. Directors may also have important statutory rights which must be addressed separately. In the UK, employees acquire the right not to be unfairly dismissed after one year's service. The removal of a director may amount to constructive, wrongful and possibly unfair dismissal, giving rise to claims for damages for breach of contract and statutory compensation. While there may be defences, it is hardly conducive to the good governance of the company to have disputes with its ex-directors, particularly if they are in the family.