Family disputes over shared assets, family businesses and other commercial interests spring up quite frequently. As the businesses expand and gain intricacies and complexity, families often aim to delineate commercial control, ownership, and management interests to achieve greater autonomy. Family settlements that allow for amicable agreements can play a vital role in the distribution of wealth and allocation of businesses/assets among family members. This was aptly illustrated by the recent family settlement of the Godrej group (particularly the aspects around the reorganization of the shareholding of the promoter group in its listed entities), which was intended to balance the varying perceptions of subsequent generations as to, inter alia, strategic direction, growth and governance of the various entities. This article analyses the various legal and corporate governance issues that may be encountered in such settlements.
Key aspects of family settlements:
- Vital elements: A family arrangement should consist of a bona fide and voluntary settlement that may be oral or written and executed by members having some antecedent title, claim or interest in the object of settlement.
- Recognition by Indian courts: Despite the lack of a legal definition in Indian law, family settlements are recognized by Indian courts based on their equitable intentions. Essential criteria include benefiting the family, transparent intentions, resolving present or future disputes, and preserving family property. Such settlements are typically subject to minimal judicial interference and considered to be ‘governed by a special equity peculiar to themselves'1; however, they will be enforced only if they are executed in good faith.
- Registration requirement: In case a written settlement aims to partition properties and declares and/or creates rights or titles for certain parties (under Section 17(1)(b) of the Registration Act, 1908), the same should be registered and not if such written settlement only acts as a record of understanding.
- Impact on corporate governance and investor confidence: These settlements can, at times, blur the lines between private and corporate spheres, potentially affecting corporate governance and minority shareholders. Disparities in governance ideologies within the private familial realm can often exacerbate family conflicts by involving the company and undermine the legitimate expectations of investors and rights of minority shareholders, transparency in management, wealth and power diversification, fair corporate policies and action, access to capital, etc. Historically, courts have shied away from lifting corporate veils to harmonise the conflicting interests of the family run businesses and the corporate entity itself. Notably, the courts in Kirloskar Industries Ltd & Ors v. Kirloskar Brothers Ltd2 highlighted the influence of family aspirations on business operations, leading to increased transparency requirements from regulatory bodies like SEBI. Critical issues of governance in family-run businesses can be found in relation to transparency in management, wealth and power diversification, fair corporate policies and action, access to capital, etc. With complex crossholdings, use of non-public trusts and private entities for owning shares of group companies, concentration of ownership and conflicting interests of family members in family run corporate groups, there is significant risk of loss of investor confidence, especially among minority shareholders.
- Implications on public listed companies: When such settlements involve the transfer of shares of listed companies, disclosures under Securities and Exchange Board of India (SEBI) Regulations are required. Specifically, Regulation 30, in conjunction with Schedule III, Part A, Paragraph A (5) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, mandates that any family settlement agreement affecting the management and control of a listed entity must be disclosed to stock exchanges. Similarly, the transfer of substantial shares of a listed entity, even as part of a family settlement agreement, may trigger compliance and disclosure requirements under the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011.
- Capital gains implications: In the context of family settlements in India, divestment of property by individual members to other members under a bona fide family arrangement is not considered a ‘transfer' under Section 2(47) of the Income Tax Act, 1961. Therefore, no capital gains tax is applicable to individuals in such cases. This exemption applies broadly to all parties in a family arrangement, not just immediate or only the lineal ascendents and descendants/blood relatives. However, for corporate entities involved in a family settlement, any divestment of property is considered a ‘transfer' under the Income Tax Act, 1961. Consequently, the usual capital gains tax provisions apply to such corporate parties.
- Fiduciary duty of directors: Section 166 of the Companies Act, 2013 establishes uniform fiduciary duties for all directors as a collective entity. The Bombay High Court in Rolta India Ltd v. Venire Industries3 held that every director's fiduciary duty towards the company attains primacy and any director on the board is bound by a fiduciary duty to act exclusively in the best interests of the company. In family-controlled businesses, there may be potential issues around corporate governance, which necessitates prioritization of corporate and stakeholder interest as opposed to individual interest. In such situations, the role of professional management in such businesses becomes critical for projecting a sense of unified and sound corporate governance to stakeholders, including investors, employees, and customers.
Given the inherent advantages of leveraging tax benefits and avoidance of prolonged court battles, family arrangements are increasingly being utilized to structure future co-existence clearly and preserve and accelerate business growth for the benefit of all stakeholders, including employees and customers. In effect, family settlement structures accommodate family complexities, provide a forum for amicable division of assets, and promote harmonious business operations moving forward. Some of the usual tools deployed to achieve these objectives are non-compete, non-solicit, confidentiality, and brand usage agreements. However, due care needs to be exercised while structuring these settlements, to avoid downstream challenges that may dilute the very purpose of the settlement exercise.
Footnotes
1. Kale v Deputy Director of Consolidation, AIR 1976 SC 807
2. Order of Mumbai Bench - I, National Company Law Tribunal dated 21 May 2024, CP (IB) No. 193/MB/C-I/2070
3. 2000 (2) Bom CR 241
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