Director of Blue Wealth Capital Raj Shah says a recent High Court case is a reminder of the importance of business owners to be open and frank about their aspirations for the future
A High Court case last year showed just how much could go wrong in relation to family business succession, following an unexpected death. When considering insurance-based share purchase arrangements for owners of private companies, less need usually arises for family businesses, where it is intended that the children will inherit the parents’ shares.
This is understandable, as no sale and purchase will be necessary and there will usually be no inheritance tax due to business relief. Although this is the general rule, there may be a need for compensation for those children who do not inherit the business. Securing life assurance in trust can often be an economic and appropriate solution.
While share transfer between generations will be a relatively trouble-free process from an economic and taxation standpoint, there are sometimes other challenges, as was seen in a recent court case – please note, we’ve changed all of the names involved in the case.
Facts of the case
ABC Fencing Contractors Limited was a private company owned and managed by the Smith family. The business was started in the early 1970s by Ken Smith and incorporated in 1978 by Ken and his wife, June, as equal shareholders and directors. Their son, Mark, worked in the business and, following his 21st birthday, Ken and June gifted to him 20 per cent of the shares in the company. Mark gradually took over running the business and was appointed as a director in 2006, as well as being a shareholder.
Mark’s sister Debbie, took a role, managing the firm’s invoicing and was gifted 20 per cent of the shares in the company in 2009 and appointed director in 2011. Debbie’s husband also worked for the company but didn’t directly own any shares.
Mark’s wife, Fiona, worked part time for ABC Fencing Contractors as a secretary and personal assistant to Mark. Their son, Aaron, also worked in the business. Despite his advancing age Ken remained active in the firm, working at least 40 hours a week.
Unfortunately, Mark died from cancer in 2017. At that time, Ken had 36.6 per cent of shares in the company, June had 23.34 per cent, Mark had 20 per cent and Debbie 20 per cent.
Under Mark’s will his shares passed to his wife, Fiona. Apart from the shares themselves, there were a number of family properties registered in Mark and Debbie’s names. There was an argument over whether the properties were owned as joint tenants or tenants in common. There was also a property in the company’s name.
After Mark’s death, relations between the family members and Fiona broke down
The company passed a resolution adopting new articles of association, which had a negative impact on Fiona’s rights. ABC Fencing Contractors dismissed Fiona and her son as employees and her as a director. The family actioned a transfer at an undervalue of the company’s 50 per cent share of a property into Ken’s personal ownership.
Fiona brought an unfair prejudice petition against the company. This is where a minority shareholder who is the victim of unfairly prejudicial conduct by the majority shareholders can obtain relief from the court.
The court has a wide discretion as to the appropriate remedy, but will often order the minority shareholder’s shares be purchased by the majority shareholders at a predetermined value.
During trial proceedings there was clearly a change of heart and the company agreed to adopt new articles that restored Fiona’s rights, offered to re-employ her son and agreed the remaining shareholders would purchase Fiona’s shares at a price to be negotiated. Because of this agreement between the parties the petition was dismissed.
During the trial Ken admitted that, when he started the company, as often happens with such businesses, no thought was given to succession. In the absence of clear discussion, presumptions therefore existed. During the trial it transpired that Fiona believed a share of the firm would pass to each side of the family, but Ken’s view was that only those who actually worked in the business would ever inherit any shares.
Need for planning
The case is a reminder of the importance of business owners being encouraged to be open and frank about their aspirations for the future of their share of the business on death or serious illness.
The financial planner has an important role to play. They are often best placed to discover and establish the wishes of the business owners in relation to share succession. Once this is established, in plain English and hopefully in alignment with all owners, core financial planning expertise can be put into practice to deliver a solution. This may incorporate a combination of wills, insurance, trusts and agreements. Of course, all should be put together in the most tax-efficient manner. The need for expert advice and, ideally, collaboration between all the client’s professional advisors is self-evident.
Raj Shah is founder of
Blue Wealth capital and
has been shortlisted for Financial Planner of the
Year and Investment
Adviser of the Year.
www.bluewealthcapital.com
