Trusts in relation to Family Businesses

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  1. As family businesses grow the owner of a company will often place shares in the company into various trusts, for his children.
  1. Trusts, if properly administered will offer protection against insolvency and will also operate effectively to peg capital growth, which will be attractive to the owner. In most instances the owner as founder of the trust will utilise a discretionary trust, where the trustees have significant discretion as regards awarding both income and capital, vesting dates, proportions etc.  This allows maximum flexibility.
  1. Family businesses are prone to intra-family disputes, particularly if the children of the founder enter the business, and the siblings don’t see eye-to-eye on matters. It is common for siblings in this situation to allow their family dynamics to intrude into the family business operations, allowing dinner table squabbles to intrude into the boardroom.  The situation is often exacerbated when the children marry and in-laws are introduced into the equation.  We can all imagine the scenario where the daughter’s husband is antagonistic towards the son, and wants to know why the son is earning more than his wife, and complains to his wife continually about this.  The using of a trust as a vehicle to hold shares in the company can be used to the advantage of a complaining family member, be it the founder’s spouse, a disenchanted child, or the dreaded children in-law, or in divorce proceedings.  I will explain below why this is often the case.
  1. Often, with family trusts, the trustees/beneficiaries who are family members do not comply with corporate governance: decisions and resolutions are not minuted, meetings are not held and if meetings are held, they are held informally and quorums are not present. These trusts are often operated as the alter-ego of the family members concerned.  This corporate governance failure allows one of the disenchanted family members the ability to attack the trust and the manner in which it was operated.  The Supreme Court of Appeal, in the Parker[1] case, determined that a trust must have at least one trustee in office who is independent, in the situation where the remaining trustees are beneficiaries and where the beneficiaries are related to each other (there also may be considerable adverse income tax and estate duty implications if there is no independent trustee in office, but that is a subject for a different article).
  1. A trust deed is the constitution of the trust, and it must be strictly adhered to. If the trust deed requires a certain quorum for any action by the trustees, or if the trustees purport to act without the authority of such quorum, or, other than strictly in terms of the requirements of the trust deed, these actions are not valid.  A disenchanted family member can take advantage of any failure to strictly apply corporate governance and can attack the trust on this basis.
  1. The SCA held in the Thorpe[2] case that for a trust to be validly bound to a contract the trustee who purports to bind this trust must have the authority of the other trustees to do so. In the absence of proper authority the assent of only one trustee to a contract will not bind the trust.  This will have serious ramifications and will allow a disenchanted family member to attack a transaction and have it set aside.
  1. In the Badenhorst[3] case the Supreme Court of Appeal disregarded the trust as a separate entity in a divorce action and allowed the beneficiary’s spouse to take into account the assets in the trust, in determining the redistribution in divorce proceedings between the beneficiary and his spouse. In doing this the Court held that the particular trust was a veneer and the alter-ego of the husband who was the beneficiary.  The Court stated “in his conduct of the affairs of the trust (he)…. seldom consulted or sought the approval of his co-trustee”.  The Court analysed the manner in which the trustees controlled the trust and found that where “the founder ….. appoints close relatives or friends who are either supine or do the bidding of their appointer….” de facto the founder controls the trust, which contravenes the fundamental principle of trusts that there must be a distinction between ownership (control) and enjoyment over the trust’s assets. In Badenhorst the Court held that the founder had retained de facto control over the trust’s assets and that he treated the trust as his alter-ego.  In my experience, many family trusts are run on this loose basis.
  1. The solution to these issues is that these family trusts must each have an independent trustee, the trustees must operate strictly in accordance with the requirements of the trust deed, meetings must be held at which quorums must be present, minutes must be kept and resolutions should be in writing and signed by the trustees. If there are separate trusts for the children, and the trusts are shareholders in the family business it is important that the shareholders agreement is bulletproof.  There should be provisions in the shareholders agreement relating to the resolving of disputes, particularly, where there is a deadlock in votes.  I suggest sealed bid (shotgun) clauses, deemed offers, or other dispute-breaking mechanisms to be included in the agreement.

David Janks

David has a BA and LLB and was admitted as an attorney in 1980. He has worked as partner and senior partner at Sloot Broido, director at Routledge Modise (now Hogan Lovells), general counsel and company secretary at the Clicks Group and consultant at Bernadt Vukic Potash & Getz. David joined Caveat Legal in 2016.

 

[1] Land and Agricultural Bank of South Africa vs Parker 2005 (2) 777 SCA

[2] Thorpe vs Trittenwein 2006 30 SCA

[3] Badenhorst vs Badenhorst ZA SCA 116; [2006] 2 All SA 363 (SCA)