PURPOSE AND PROCEDURE FOR DRAFTING A FAMILY CONSTITUTION

BY Dr. Vinod Surana

Introduction

A family constitution is a charter that documents the values and principles of a family business. The contents of a family constitution underline the values and principles of the business while also providing reference points for decision-making concerning ownership and management. Since no family has the same composition or structure, a family constitution will vastly differ. Even in terms of conflict resolution, a family constitution will address the tribulations that that particular business can possibly take as per its past history.

Merely having a family constitution in place, does not mean there will be an answer to every single issue that may arise in the family and/or company. The economic bonds of the family are easier to navigate than emotional bonds and circumvention of conflict is difficult. What the constitution does is essentially create a bridge between business and family affairs in order to provide a bankable governance mechanism between the family members and the managers of the company. It also provides a blueprint for managing conflicts, ego, and succession issues as safely as possible. Providing a firm basis for addressing and understanding changes in succession prevents erosion of family structure in the event a key individual backs out, allowing the business to thrive independent of the family as well as providing a guide for ownership changes.

Features of A Family Constitution

The primary objective of a family constitution is to articulate the shared vision and goals that characterize the business, including unique features ofboth the family and the business espoused, akin to a corporate mission statement. Also in similar fashion to a corporate mission statement,a family constitution would define the organization and its reason for existence,as well as identifying the primary demographic it caters to.

Certain matters must be addressed in family constitutions including:

• The family values that the entire organization subscribes to need to be put down in order for posterity and to ensure that the nucleus of the idea that created the business is preserved. This allows the business to expand without losing its founding values.
• To further protect core values there need to be rules for nominating and training successors. This means detailed procedures for assessment and appointment in a twofold capacity: a set of rules for management as well as a set of rules and processes to nominate future individuals to the family council or the Board of Directors in the business.
• Since it is important to have an overseeing Board of Directors, the composition of  theboard is crucial. There must be a detailed conduct policy to prevent wrongdoing.Importantly, the weight of each family member’s (and their potential successor’s) vote must be clearly delineated alongside the rights and obligations of all shareholders to prevent overlap and maintain a reliable voting system..
• Consideration must also be provided for external and non-family ownership. Would a person unaffiliated to the family be able to secure a vote? Would succession to the family vote be based off direct lineage? Each of these questions must be answered to prevent confusion. Some constitutions take it a step further by putting forth a mandatory retirement age for family directors.
• Usually, a family constitution is used to further transparency. Communication and disclosure policies therefore are key to conflict management, especially when considering the process for resolving interfamilial disputes. Conflict management provisions might includelaying out processes for buying out family shareholders or remuneration to family members in the business. The level of transparency each business demands is highly specific to each business.

Good governance processes are necessary to prevent members from tampering with the structure of the business. This might be done by indemnifying or exculpating fiduciaries, controlling the dissemination or information, and actively requiring the seeking of approval for fiduciary acts and transactions. Such structuring helpsprevent money-grab tendencies or power plays within the business and protects itscore tenets.

Principles Underlying a Family Constitution

Since a template governance document like a shareholder agreement or company bylaws is unsuitable for a family constitution, it is difficult to draft. Consequently, there are a set of principles that define the constitution rather than a set of boilerplate clauses. The ethos of theconstitution will be the family philosophy and values, and drafting of the constitution is guided by those same principles. Articulating these principles allows forfuture reference and adds  distinctive value. An understanding of the family’s history and its enduring traits provides a feeling of close-knit kinship within the company rather than a rigid bureaucratic hierarchy. This could also help key stakeholders from feeling disengaged insofar as they are involved in the process of discovering and documenting the common values.

That same sense of unity presentsa double-edged sword. The family constitution being a largely emotive and living document can also touch exposed nerves and unresolved feuds. Family feuds may be dredged up if the family constitution revolves around past history. Efforts must be made to smooth conflicts and prevent dwelling on past disputes.

Secondly, a framework for making decisions and changes is imperative. Some families might prefer a skeletal guideline system, allowing for members to still be roughly autonomous in their decision-making, whileothers might set down a list of rules that members must follow.

An ideal family constitution needs to be evolving. This means that a decision-making frameworkneeds to put forth a mechanism for evolving policies and making decisions, ensuringfuture snags are dealt with in the most optimum manner without compromising on the core tenets of the constitution. The framework must necessarily be flexible enough to account for addressing future roadblocks. The issue of obsolescence of the family constitution consequently becomes slim.

Preliminary Steps for Creating a Family Constitution

It is important to lay the groundwork before proceeding to draft a family constitution. This allows an educated opinion for all individuals involved,acts as a risk assessment mechanism., andhelps assuage misgivings family members might have.There is a two-fold mechanism for preparing foundation that needs to be performed before drafting a lasting family constitution.

1. Consultation and Appraisal

Ascertaining a constitution’s viability is the crucial preliminary step to proceeding with drafting. To create the family business, a potential review of the family and its values maybe done. , A process consultant can help enter into the business venture knowing one’s prospects and understand the risks. A process consultant structures the decisions taken to set up the constitution and the family hierarchy. Consequently, the process consultant needs to work in tandem to the natural gravitation of the family power dynamic and must do an assessment of the family to understand what roles best suit the individuals. The general procedure for said assessment would mean one-on-one interviews with the key family members.. However, the consultant needs to juxtapose professional advice with boundary maintenanceand cannot prevent the family from making any decisions. It will be necessary for the consultant to look at both basic corporate functioning (share ownership arrangements and compositional board rule) and family information. Both personalized and objective assessmentsand fact-finding consequently form the basis for a family constitution.

• Forming the Family Governance Board

The candidatefor the Family Board now assembles, co-operating on a hands-on processto understand how to proceed and make decisions. Compilingshared goals and values of the family must through communal understanding is requisite to a fertile and lasting partnership

The basis of the corporate governance systems must also be formed here. The family line representatives should mutually agree upon the terms of the constitution and regulation of the business. Prior to drafting, company hierarchy must be delineated.A key provision is an annual reviewing process amongst the family in order to update the constitution, alongside regularreviews at all points following from assessments to ensure accountability and professionalism.

What is the Drafting Procedure of a Family Constitution?

It is recommended that after the preamble, the constitution delves into business governance.

Why start at governance? Usually, employment qualifications should take precedence before governance practice. It must be kept in mind, however, that a family business starts out as a nucleacompany. Hiring and firing is limited to the family, but governance can be tricky to maneuver in the family. Consequently, there need to be provisions for the compositionand qualifications of board members and regularity of family meetings. Furthermore, provisions for membership and communication between the board, family and management need to be provided herein, preferably accompanied by a successor selection process.

Within governance, it is also important to appoint trusted neutral parties not involved in the family; thus, appointment of professional advisors and the criteria they need to fulfil in order to provide said advice is paramount. They deliver a foil to the family dynamic and can assist in business valuation methodology. It is also crucial to discuss ownership and voting rights amongst the individuals, so that the dispute resolution process can be smoothened out. Since the business is based out of the family, estate plan communications, coordination and agreements would be important to deal with.Furthermore, unlike other businesses, a marriage contract arrangement may also have to be addressed.

It is subsequentlynecessaryto delineate employment in the family business. Since the governance is agreed upon, qualifications and conditions for employment can be better regulated. This includes a regular performance review and consistent compensation, inclusive of severance and retirement. Furthermore, a hierarchy and reporting relationship can be set up under the heads of the business to ensure smoother functioning.

As noted a procedure for renewal, amendment and revision of the constitution is critical. It is impossible to create a single document that will stand the test of time and it is highly likely that the family constitution in its original form will become obsolete. For a truly lasting constitution, the family needs to anticipate future changes and provide a transparent amendment process. A review mechanism can also ensure that the constitution in its amended form still retains the ethos of the original constitution and can rectify any brewing discontent that had since come to light.

Conclusion

In the absence of a formal management succession plan, several lasting issues may arisethat would take generations to fix. Eroding the trust that the family business has set up in the current generation could cause permanent damage. Finding a good succession plan and making a well-structured future business model taking into account all the opinions of the key stakeholders can be done by early planning. Flexibility and guidelines laid by the constitution could ensure the longevity of a family business over its competitors while also maintaining harmony within the dynasty.