James F. McDonough
Of Counsel
732-568-8360 jmcdonough@sh-law.comReconciling Divided Loyalties: The Collision Between Fiduciary Duties of Trustees and Company Managers.
Author: James F. McDonough|April 1, 2014
Reconciling Divided Loyalties: The Collision Between Fiduciary Duties of Trustees and Company Managers.
Invariably, wealth transfer structures encounter changing circumstances as the founding generation grows older and passes away. Typically, company managers dominate decision-making for a period of years. Unfortunately, if one of the members of the next generation is designated to take charge to the exclusion of others, the excluded members may resist. Even more dangerous is management by committee, where individuals with different abilities, goals and personalities mix in a caldron and boil over in conflict. Alternative dispute resolution methods are touted as a means of resolving conflict. The problem is a negotiated settlement may be an albatross around the neck of the business. Although the dispute is settled, success may not follow.
Operating agreements and partnership agreements for family structures are drafted for the approval of the patriarch and rarely undergo revision. Control is maintained by personality as well as position. Successor managers are often adult children of the patriarch and may also be trustees of a family trust that will be divided among the siblings after both parents pass. Even more complex are the relationships among the duties of a successor who is also a trustee of a GST exempt trust for the grandchildren of the patriarch. The adult child may be receiving a salary from a business that she is also responsible for monitoring in her capacity as trustee.
A breach of duty may arise when a sibling is a manager of a limited liability company and also a trustee of a family trust. The goals of the business or investment partnership may not fit with the need of a trustee for cash for distributions to beneficiaries of the trust. Salaries, capital expenditures and investment strategies are areas ripe for dispute. Even more difficult are issues relating to compensation where not all family members are employed by the business. Disputes arise frequently when unequal numbers of grandchildren from each branch enter the family business and burden it with inflated salaries.
There are differences in state law on the duties owed by one party to another. In Delaware, parties have the freedom to enter into a contract, called an Operating Agreement, and have its terms respected by a court. In other states, duties and obligations may be imposed that cannot be changed by agreement. Thus, choice of state law may deprive the patriarch of an opportunity to set forth a standard and procedure to govern the resolution of future disputes.
Although important but seldom discussed, are the responsibilities and burdens imposed by state law upon an adult child who becomes a manager. Delaware law permits the elimination of fiduciary duties in the Operating Agreement. Typically, that same agreement would require that conflicted transactions be fair and reasonable. This means that conflicted transactions must be no less favorable than those terms provided to or by third parties.
Delaware’s implied covenant of good faith and fair dealing does not override express provisions of the contract, but it will inject terms into the agreement if issues are not addressed. The patriarch should decide if reliance upon an appraisal or fairness opinion is sufficient to defeat claims of a disgruntled family member. Also, should a super majority vote (two-thirds or more) be sufficient to ratify the decision as being fair and preclude a claim. It may not be possible to prevent a dispute, but it may be possible to establish criteria by which it is decided.
Reconciling Divided Loyalties: The Collision Between Fiduciary Duties of Trustees and Company Managers.
Author: James F. McDonough
Invariably, wealth transfer structures encounter changing circumstances as the founding generation grows older and passes away. Typically, company managers dominate decision-making for a period of years. Unfortunately, if one of the members of the next generation is designated to take charge to the exclusion of others, the excluded members may resist. Even more dangerous is management by committee, where individuals with different abilities, goals and personalities mix in a caldron and boil over in conflict. Alternative dispute resolution methods are touted as a means of resolving conflict. The problem is a negotiated settlement may be an albatross around the neck of the business. Although the dispute is settled, success may not follow.
Operating agreements and partnership agreements for family structures are drafted for the approval of the patriarch and rarely undergo revision. Control is maintained by personality as well as position. Successor managers are often adult children of the patriarch and may also be trustees of a family trust that will be divided among the siblings after both parents pass. Even more complex are the relationships among the duties of a successor who is also a trustee of a GST exempt trust for the grandchildren of the patriarch. The adult child may be receiving a salary from a business that she is also responsible for monitoring in her capacity as trustee.
A breach of duty may arise when a sibling is a manager of a limited liability company and also a trustee of a family trust. The goals of the business or investment partnership may not fit with the need of a trustee for cash for distributions to beneficiaries of the trust. Salaries, capital expenditures and investment strategies are areas ripe for dispute. Even more difficult are issues relating to compensation where not all family members are employed by the business. Disputes arise frequently when unequal numbers of grandchildren from each branch enter the family business and burden it with inflated salaries.
There are differences in state law on the duties owed by one party to another. In Delaware, parties have the freedom to enter into a contract, called an Operating Agreement, and have its terms respected by a court. In other states, duties and obligations may be imposed that cannot be changed by agreement. Thus, choice of state law may deprive the patriarch of an opportunity to set forth a standard and procedure to govern the resolution of future disputes.
Although important but seldom discussed, are the responsibilities and burdens imposed by state law upon an adult child who becomes a manager. Delaware law permits the elimination of fiduciary duties in the Operating Agreement. Typically, that same agreement would require that conflicted transactions be fair and reasonable. This means that conflicted transactions must be no less favorable than those terms provided to or by third parties.
Delaware’s implied covenant of good faith and fair dealing does not override express provisions of the contract, but it will inject terms into the agreement if issues are not addressed. The patriarch should decide if reliance upon an appraisal or fairness opinion is sufficient to defeat claims of a disgruntled family member. Also, should a super majority vote (two-thirds or more) be sufficient to ratify the decision as being fair and preclude a claim. It may not be possible to prevent a dispute, but it may be possible to establish criteria by which it is decided.
