In February 2020, we published the third in a series of articles that explore the value of family offices for high-net-worth Chinese families. In this fourth article, we will provide an overview of the different governance considerations that high-net-worth families should consider when establishing family offices.
Proper governance and management structures are crucial for the success of family offices. Governance structures ensure that family wealth is managed in accordance with the family office's purpose and vision, whether in investment, succession planning, or philanthropy. Governance structures can also minimize family conflict by providing mechanisms that ensure family-related decisions are made in a fair and transparent manner. Finally, a centralized governance structure can provide confidentiality for high-net-worth families since family-office services report directly to family-controlled boards. In this article we will discuss three components of family office governance and the legal considerations accompanying these components.
Family Constitution
As a preliminary step, family members should consider the fundamental purpose behind their family office. A clear purpose and vision for a family office will inform governance considerations. One way for family members to organize and document their purpose and vision is through a family constitution. A family constitution serves two main functions: (i) it governs the relationships between different family office stakeholders, and (ii) it outlines the core principles of the family office's operations. A family constitution is generally not binding on family members. However, it can influence the drafting of other legal documents, including the articles of incorporation, trust deeds, and employment agreements. The role of a family constitution becomes particularly important in large, multi-generational families, in which family elders envision the family office's operations continuing for several generations. For these reasons, family constitutions, which may be adopted at later stages, are more useful if adopted earlier. Similarly, a family constitution can implement structures that guide the family office through future events that are both expected (the death of elderly family members) and unexpected (family disputes, sudden illnesses, divorces).
Legal Considerations
A family constitution should begin by outlining the family office's core principles, including any purposes, values, and philosophies. These principles will guide the family office's operations and unify family members around key organizational ideals. In considering these core principles, family members may consider several aspirations for their wealth, such as philanthropy, providing for future generations, or investment. Having established the core principles, family members should next consider the governance bodies that are required to execute these organizational ideals, such as boards of directors or trustees and family councils, both of which are discussed below. A family constitution should also address issues surrounding ownership, including share ownership of family office corporations and beneficial ownership of family trusts. Similarly, a family constitution may address the family office's employment policy, including the qualifications required for certain key positions (such as the chief executive officer or chief financial officer) and remuneration policies for family members employed in the business. Finally, a family constitution should address how family assets are to be shared amongst family members, for example through shareholder agreements, compensation agreements, and succession plans.
Board of Directors or Trustees
Having drafted the family constitution, family members should next consider the governance bodies of their family office. If the family members decide to incorporate their family office, their decision would start with the board of directors. The first board of directors are designated through the family office company's articles, and thereafter directors are elected by the company shareholders. In British Columbia, directors are governed by the Business Corporations Act (the “BCA”), which imposes a fiduciary duty on directors and requires them to act honestly and in good faith with a view towards the company's best interests. If the family members decide to operate their family office through a trust, then the selection of trustees becomes critical. A family trust may contemplate a board of trustees that work collectively to make decisions regarding the family's assets, such as investments and distributions. The trustees would also be responsible for administrative matters such as the tax obligations of the trust. When determining the make-up of the board of directors or trustees, a family office should consider selecting a mixture of competent family members, trusted advisors, and independent third-parties that will provide objective advice on the family office's business affairs.
Legal Considerations
The articles of a family office company establish the rules for the company's conduct. In British Columbia, the BCA sets out minimum requirements for a company's articles, including any restrictions on the types of business the company can carry out and the special rights and restrictions attached to each class or series of shares of the company. Other key considerations for a company's articles include voting procedures at director and shareholders' meetings and the mechanisms for electing and removing directors from the board. A family office should carefully consider the voting thresholds required for certain decisions, including those involving family assets, as these decisions will have a significant impact on the long-term viability of the family office.
Where family members decide to operate their family office through a trust, the trust deed becomes the most important document. A trust deed should appoint the initial trustees, establish voting procedures for major decisions involving family assets, and outline mechanisms for replacing or removing trustees. In British Columbia, a trustee's duties and powers are governed by the Trustee Act, which imposes a standard of care on trustees with respect to investment of trust assets.
Family members may also consider a hybrid structure to manage their family wealth, in which a family trust controls and sits atop of multiple corporations established to hold different assets. Under this structure, the family trust would be the shareholder of each of the corporations and the trustees are empowered to appoint and elect directors (who may be individuals drawn from outside the board of trustees) to manage the respective corporations. This hybrid structure is useful where family members wish to segment their assets for different purposes, as corporations are commonly established to explicitly manage or deal with single properties or investments.
Family Council
In addition to a board of directors or trustees, a family office may consider establishing a family council for a second layer of corporate governance. A family council is a separate governance body that focuses primarily on family matters. A family council does not usually have the decision-making capabilities with respect to business affairs as the board of directors or trustees, and serves primarily as consultative and informative body for the family itself. Key responsibilities of a family council include (i) educating family members not involved in the business side of matters about financial results, estate planning and investment strategies; (ii) providing a forum for conflict resolution between family members; (iii) grooming the next generation of family members for leadership roles within the family office, and (iv) facilitating communication between the board of directors or trustees, management and family members. For this reason, a family council should include younger family members, family members not involved with the business affairs of the family office, and trusted family advisors.
Legal Considerations
A family council should consider having a governing document, such as by-laws, to formalize and guide its role within the larger family office structure. Unlike a board of directors or trustees, a family council is not regulated by statutes. Therefore, its role in the family office can be flexible and tailored to the needs of family members. Among the key issues to be addressed in such a governing document are (i) the need for family council meetings; (ii) the role, if any, of the family council in determining the business affairs of the family office; (iii) mechanisms for dealing with internal family disputes, particularly as they relate to family-wealth related decisions, and (iv) communication policies with other bodies within the family office, such as the board of directors or senior management. By formalizing the role of a family council, a family office can ensure that all relevant family members are on the same page with respect to the family offices' mission and values, and that the next generation of family members have an avenue through which to learn about the family business and contribute towards its continued success.
Originally published Lawson Lundell, May 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
